In 2020, the number of homeowners in the United States has risen by 2.1 million compared to the previous year. According to Pew Research Center, this is the seventh-largest increase in the percentage of homeowners since 1965.
So why are so many people wanting to own their homes? It’s simple. There are so many benefits to owning your own home, land, or any other type of real estate. You’re investing in an appreciating investment, meaning it will gain value over time.
In addition, owning your own home provides you with more stable housing costs compared to renting, tax advantages, and the freedom to do as you wish on your own property. What’s not to love?
For most Americans, a mortgage loan is required in order to purchase a home. If you’ve ever dreamed of buying a house or owning your own land, it’s crucial to understand what mortgages are, how they work, and what options are out there to best suit your needs.
A mortgage is a type of loan that is used to buy or maintain real estate. When you get a mortgage, you agree to pay the lender back over time, typically in a series of monthly payments. These payments include your principal loan amount as well as the interest on the loan.
Mortgages are commonly referred to as secured loans, meaning they are secured with collateral of some sort. In this case, your property would serve as the collateral.
When you apply for a mortgage loan, your lender will make sure you meet several requirements like having a certain credit score and enough money for the down payment.
When you find the right lender and qualify for the mortgage, the process of underwriting begins. Your lender takes the information that you provide to them and they conduct some research to determine the degree of risk they face by approving the loan. That research includes assessing your income, debt, savings, credit score, credit history, and other deciding factors.
Once the underwriting process is complete and you’re approved for the loan, you enter into the closing phase. This is the part where contracts are signed and agreements are made. Once everything is signed and documented, the home is yours.
Now that you know a bit about how mortgage loans work, it’s important to understand that mortgages aren’t a one-size-fits-all deal. There are many different types of mortgage loans out there. Picking the right loan for you can save you time, money, and stress in the long run.
A major part of buying a home is picking the right type of mortgage loan. Not all loans are created equal, and some types of loans will only make sense to certain individuals depending on their circumstances. Here are five different types of mortgage loans and a breakdown of their advantages and disadvantages.
1. Fixed-Rate Mortgages
Fixed-rate mortgages are the most common type of mortgage out there. They are also commonly referred to as conventional loans. As the name would suggest, fixed-rate loans will have the same monthly payment and interest rates throughout the duration of the loan. Monthly payments consist of your principal amount, interest, taxes, and insurance.
Fixed-rate mortgages are typically available in 10, 15, 20, 30, or 40-year durations. If you want to keep your monthly payments low, you would want to opt for a 30 or 40-year loan. If you want to pay less interest and can afford a higher monthly payment, a 10 or 15-year loan might be more suitable.
Advantage: These loans are extremely transparent. You will know what your payment is each month and that amount will not change.
Disadvantage: If you opt to get a fixed-rate mortgage for a 30 or 40-year duration, you may be paying thousands in interest over time.
2. Interest-Only Mortgages
Unlike fixed-rate mortgages, where you would pay for both the principal and interest right off the bat, an interest-only mortgage allows you to forgo paying the full loan payment right away. In some cases, borrowers can take advantage of paying only the interest portion for up to 10 years.
Advantage: Your monthly payments may be reduced for the first few years of your mortgage. The money you are saving could be set aside for future payments or used in other areas of your life.
Disadvantage: Although the payments on the principal loan amount are delayed, you will need to make payments on it eventually. Ultimately, borrowers going this route will spend a longer amount of time paying off the loan.
3. Adjustable-Rate Mortgages
Adjustable-rate mortgages (ARM) are mortgages that don’t have a set monthly interest rate. The interest rates on these loans change from month to month, depending on the changing economic conditions.
ARM’s oftentimes will start as a fixed-rate loan for the first few months of the mortgage. After the fixed-interest period has ended, the interest rate will be determined by something called the ARM index. The ARM index derives its rate from the prime rate, short-term US Treasury Bond rates, and the Federal Reserve Fund rate.
Advantage: Having an ARM can save you money if the economic conditions are right and interest rates are low.
Disadvantage: Unlike with other loans, you will not know how much your interest rate may rise. This may put you in a situation where the payment becomes unmanageable.
4. VA Loans
VA loans are only available to those who are members of the US Military. In some cases, spouses may also be eligible for VA loans. These loans also do not require a down payment. This makes homeownership much more accessible to members of the armed forces.
Advantage: These loans are specifically designed to make it easier for veterans to buy a house.
Disadvantage: If you are not a member of the military or the spouse of someone who’s in the military, you will not be eligible for a VA loan.
5. FHA Loans
These loans are granted by the Federal Housing Administration (FHA) and are available to qualified borrowers who meet the minimum credit score and down payment requirements. The down payments on FHA loans can be as low as 3.5%, while conventional fixed-rate loans require a down payment of around 20%.
There are four main types of FHA loans to choose from: Home Equity Conversion Mortgage, FHA 203(k) Improvement Loan, FHA Energy Efficient Mortgage, and Section 254(a) Loan.
As you can see, there are many different avenues to explore when it comes to FHA loans. For a full breakdown, be sure to check out this article.
Advantage: FHA loans have made it easier for people to become homeowners. Since the FHA was introduced, homeownership rates have risen to nearly 68% as of the second quarter of 2020.
Disadvantage: If you have bad credit, a few of these FHA loans may be off the table.
Sometimes, having bad credit can put a major damper on things. The lower your credit score, the less buying power you have. When you go to apply for a loan, you may be facing higher interest rates or denial from getting the loan altogether because of a low credit score.
If your credit needs some work, here are a few tips for you to help you get a mortgage loan that works for you.
Tip #1: Rebuild Your Credit Before Applying for a Mortgage
Many people with lower credit scores might be better served by taking some time to rebuild their credit before taking on a mortgage that could come with a high interest rate.
Even if you’re approved for a mortgage loan with a low score, the chances are that the interest rate on that loan will make the loan unaffordable and put you in even greater financial danger.
Get Free Copies of Your Credit Reports
The first step to rebuilding your credit is to get to the root of the issue. Every 12 months, you are entitled to receive free copies of your credit report from the three major credit bureaus – Experian, Equifax, and TransUnion. Here are ways you can get yours for free or for a fee.
It’s important to get copies of all three credit reports. It will give you a full picture of what’s going on and what you can improve.
Dispute Any Negative Marks on Your Credit Reports
Once you’ve received your free credit reports, you can now take steps to remove any negative remarks by disputing those claims. This is commonly done by getting in touch with previous lenders, debt collection agencies, and/or the credit bureaus to correct any mistakes that could show up on your credit report.
For an idea of what you can dispute on your report, check out these Free Credit Dispute Letters to Fix Your Credit.
Practice Good Credit-Building Habits
It’s important to not only remove negative marks on your reports but to also practice good habits when it comes to your credit. This includes paying your bills on time and readjusting your budget to prioritize paying off existing debt.
Another big credit-building habit to practice is to keep your credit utilization ratio low. This means avoiding using more than 15 percent of your available credit.
The credit rebuilding process can take anywhere from six months to a year, so patience will be key. Through discipline and consistency, you can improve your score to make homeownership attainable.
Tip #2: Shop Around for the Best Rates
After you’ve taken time to improve your credit, you can begin speaking to qualified lenders to let them know about your progress. Shopping around for the best rate can save you thousands in the long run.
Take time to research different lenders and take into account the experiences their past clients have had with them. If they have too many bad reviews, make sure you have several backup options.
Tip #3: Apply for an FHA Program
Even if you aren’t able to make huge changes to your credit score, there are still options out there for you. The Federal Housing Administration (FHA) can help you get to your end goal.
When you apply for an FHA Program, it is important to know that the FHA will not lend you the money for the purchase of your new home. Instead, they simply guarantee a loan that will then be approved by a lender. This means that they will pay back the loan entirely even if you default on the loan.
Getting an FHA-approved loan can greatly increase your chances of getting approved for a mortgage loan. With that being said, not everyone will be approved. Check out the FHA website for a full overview of the credit requirements and see if you’re eligible.
Tip #4: Get an Adjustable-Rate Mortgage (ARM)
If you have poor credit, you can almost guarantee that interest rates from a conventional loan will be extremely high. Because this isn’t tenable for most borrowers, the option of an adjustable-rate mortgage (ARM) may be more appealing.
With an ARM, consumers can keep interest payments low for some time which can make the monthly payments more manageable. As discussed earlier, a disadvantage with an ARM loan is that the interest rate varies from month to month. If your interest rate rises too much, the monthly payment may become unaffordable.
Before you take out an ARM loan, be sure to ask yourself and your lender these important questions:
- How much will by interest rate fluctuate with each adjustment?
- How often will my rate go up? And at what point will it go up?
- Is there a limit to how much interest can be charged?
- Are there any caps on how much the rate could increase?
Having the answers to some of these questions can help you make a more informed decision on whether an ARM loan will work with your financial circumstances.
Tip #5: Get a Co-Signer
Another option for anyone with credit that needs some work is to get a co-signer. Having someone who can vouch for you and be responsible for the loan if the payments are not being made can be a very difficult way of getting a mortgage.
If you decide to go this route, it is important to understand that this is a risky option in that it could seriously impact the relationship you have with your co-signer if things go south.
If you decide to take the chance, make sure you feel confident that you can make the monthly payments. The last thing you want is to destroy a close relationship between a family member or friend.
As far as investments are concerned, owning a home is one of the largest and most important investments you can make. With that in mind, it’s crucial to know how you can best leverage your home investment in a way that makes the most financial sense.
Here’s where refinancing comes in. After you get a mortgage loan and own the home, you can refinance your mortgage to lower your monthly payment, shorten the loan term, or even receive cash from the equity you have in your home.
How Does Refinancing Work?
Mortgage refinancing refers to the process of replacing your existing home loan for a new one. During refinancing, the old loan is paid off by the new one, leaving the borrower with just one single loan with one monthly payment. Here’s how it works step-by-step.
Step 1: Apply to Refinance
The first step of refinancing a mortgage is to apply for a refinance with your lender. Similar to when you first bought the home, your lenders will review your income, assets, debt, and credit score to assess whether or not you meet the refinancing requirements.
Something to note is that you aren’t obligated to refinance with your current lender. Those who choose a new lender will have them pay off the current loan, which will effectively end the relationship with the old lender.
Step 2: Lock in an Interest Rate
After approval, you may be provided with the option to lock in your interest rate before the loan closes. Rate locks usually take anywhere from 15-60 days.
Aside from locking in a rate, lenders may also give you the option of floating your rate. This means that you are choosing to forgo locking in a rate before the loan closes. There is some risk involved with floating your rate… you may be paying more or less than what was first offered.
If you’re pleased with your locked rate, it is recommended to proceed with that so you don’t have to risk paying a higher rate when the loan closes.
Step 3: Underwriting
As mentioned earlier, lenders use the underwriting process as a way to review all of the information you’ve provided and weigh the risks of lending you the money you need to refinance.
Lenders will also review the details of the property in question by taking a look at when you bought your home in addition to the home’s appraised value. The refinance appraisal is critical in the refinancing process because it determines what options are available to you, the borrower.
Step 4: Have Your Home Appraised
Before you refinance your mortgage, a home appraisal must be ordered by the lender. Once set up, an appraiser will visit the property and give an estimate of the home’s value. Making a good first impression on the appraiser is crucial if you’re looking for a top-dollar appraisal.
Make sure that your home is clean and that any minor repairs have been taken care of. It would be worthwhile to create a list of upgrades that you’ve made to the home so that the appraiser is aware of the improvements that have been made to the property.
If the home’s value is equal to or exceeds the loan amount you’re looking to refinance, then the underwriting process will be complete. If the appraisal estimate is lower than expected, you can either decrease the amount of money you want to refinance or cancel the refinance application altogether.
Step 5: Close On Your New Loan
After the underwriting and home appraisal processes are complete, the last step is to close on your new refinanced loan. At the closing, you can expect to go over the details of the loan. This is the time where you’ll pay any additional closing costs that aren’t included in the loan itself.
Once all the documents have been signed, you can consider the loan closed. However, there is a 3-day grace period after closing that allows you to back out of the refinance for whatever reason.
Reasons to Refinance
Now that you know how the refinancing process goes, here are some reasons why refinancing your mortgage could be a good idea
- You can shorten or lengthen your loan term.
- In many cases, you’re able to lower your interest rate.
- You can change the type of mortgage loan you currently have.
- You can cash out on the equity of your home.
Before you dive in and refinance your home, make sure you are confident in the process and shop around to find the best lender possible. Here’s an article with even more information on the ins and out of refinancing your mortgage: How to Refinance Your Mortgage.
Getting a mortgage can seem unattainable and far off at times. After all, getting a mortgage and owning a home is a major life decision! With that being said, the first step you can take towards homeownership is to educate yourself as much as possible.
Learning what types of mortgage loans are available to you can save you so much time, stress, and money. Remember to always weigh your options, compare lenders, and do your research before jumping into any big financial commitment.
For a plethora of information regarding credit repair, mortgage loans, and everything in between, feel free to peruse our site. You may be surprised by how much information is available to you right at your fingertips!