Basic terms for financing a home
If you’re buying a home for the first time, the financing terms can be an overwhelming issue to address. But it is a very important one, and the best way is to sort it out as soon as possible. The first thing to take a close look at is your personal finance. Depending on your income, your credit score and the amount of money that you think you can afford in paying on a monthly basis, you can define the home price you can afford.
The most common types of mortgage loans are three:
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Conventional loans are not insured or guaranteed by the federal government and usually have fixed rates. Usually there are harder to qualify for depending on your credit score, your income level and your down payment, but still they are the most common type of loans. Conventional loans can be divided in conforming loans or non-conforming loans. Conforming loans comply with the guidelines set forth by institutions like Freddie Mac or Fannie Mae. One very important guideline is the loan limit for example – $417,000 for single family home. The financial institution that hands out your loan usually packages the loan and sells securities on them in the secondary market.
Loan above the amount of $417,000, are also known as a jumbo loans. It can be said that they are also a non-conforming loan. Each lending institution determines the guidelines set to offer terms on the jumbo loan.
These are loans guaranteed by the Federal Housing Administration (FHA) – Department of Housing and Urban Development. The conditions of an FHA loan are easier to qualify than for a conventional loan. It requires less down payment (as low as 3%) and more relaxed credit requirements and lower upfront loan costs.
The US Department of Veterans Affairs (VA) guarantees these loans. They allow veterans and service people to have access to a home loan with good terms that include no down payment, and in most cases are easier to qualify for.
When pricing a home mortgage loan, lenders will need to have a good idea on two important factors: The loan to value ratio (LTV) and the debt-service coverage ratio. Loan to value ratio is sorted by dividing the loan amount by the purchase price of the home. Lenders usually consider that the higher the loan to value ratio is, the higher the risk is and the more expensive the loan should be.
The debt service coverage ratio is determined by dividing the borrowers monthly income by the mortgage cost. Borrowers should try to have an income as high as possible (even through part-time extra jobs) in order to get better rates from lenders.
The other big thing to consider when applying for a loan is whether to obtain a fixed rate or a floating rate mortgage. In a fixed rate loan the borrower has the same conditions for every month of the whole term of the loan. The monthly cost will be the same through the entire loan time.
Floating rate mortgages like adjustable rate mortgage (ARM) and interest only mortgage, are usually less expensive than fixed rate mortgages. They are designed to help first time homebuyers or buyers that think their income will increase in the time of the loan. The increase in interest rates is difficult to foresee, especially if you think of several years of the time of the loan. But there is always the possibility of interest rates going up in the future.
Last but not least important term to finance a home is the period of it. There are two main types of mortgage periods: 15 and 30 years. The total cost of the whole loan is lower in 15 years then in 30 years.
Having the possibility of knowing what your monthly mortgage costs will be over the years is a great advantage and source of peace for potential homebuyers.