One of the most fundamental aspects of buying a home is figuring out how you are going to afford it. Most home buyers take out long-term loans called mortgages that give lenders a claim on the home should you forfeit. Factors that go into financing a home purchase might include determining the best type of mortgage for your means; understanding the mortgage rates that may be available in your area; and figuring out whether you qualify for a mortgage to begin with. For first time home buyers, seeking and qualifying for mortgages can be a bewildering process, although home ownership typically improves your credit rating. This section includes articles to help you understand these and other basic information about mortgages and loans so you can feel confident when you walk into a lender’s office.
Mortgages at a Glance
A mortgage is generally defined as a transfer of real estate interest (such as a home or parcel of land) as security for repayment of a loan. The lender fronts the cash necessary to complete the purchase, but may foreclose on your home and sell it to pay off the loan if you stop making your monthly mortgage payments. The amount of interest you pay is determined by a number of factors, including the current prime interest rate set by the Federal Reserve and the borrower’s credit worthiness and amount of cash for a down-payment.
Types of Mortgages: Fixed Rate vs. Adjustable Rate
The interest rate of your mortgage will be either fixed or adjustable, each with its own pros and cons. As with any loan, make sure you fully understand the long-term implications of each. As it sounds, a fixed rate loan will charge you same interest rate for the life of the loan, typically 15 to 30 years, but you also must pay a small premium to secure a decent fixed rate. An adjustable rate mortgage (or ARM) is much less predictable. You start out paying a rate that’s based on the prime rate, often at a relative discount, but it fluctuates with the prime rate for the life of the loan.
The main advantage of a fixed rate loan is its reliability and predictability — you pay the same rate each day of the month for the life of the loan. These are usually the best option for borrowers with good credit and money for a down payment. They also cost a bit more upfront than ARMs.
ARMs usually have lower monthly payments than their fixed rate counterparts, and they could even go lower if prime interest rates also drop. For this reason, they tend to be more affordable for some first-time buyers; and they also don’t require as much of a down payment. But they also are subject to upward monthly payment fluctuations, sometimes to the point where the homeowner has to sell.
Types of Lenders
Borrowers have some choices when seeking financing for a home, including mortgage brokers/bankers, direct lenders, and secondary market lenders. The type of lender you choose will depend on your own particular means and needs.
- Mortgage Bankers/Brokers – A broker can submit your loan application to various lenders and can offer many different types of loans; they often charge processing and origination fees
- Direct Lenders – These lenders, typically banks and credit unions, loan money directly to the borrower
- Secondary Market Lenders – These include the institutions most commonly referred to as “Fannie Mae” and “Freddie Mac”
Mortgage Down Payment
Most mortgage lenders require a down payment ranging between 5 percent and 20 percent of the purchase price, which can seem insurmountable for many first-time buyers. Saving money or using equity from a different home are your best bets, but may not be obtainable for all buyers. Other options for pulling together the cash for a down payment include using money from an IRA; borrowing from your 401(k) plan; borrowing from friends and relatives; applying for a home loan down payment assistance program; or taking out a second loan.