2024 Guide To Home Loans

If you are a first time homebuyer, there may be several reasons why you’re contemplating such a big transition. You might be tired of annual rent increases, and of paying rent in general – it’s money that you’ll never get back, compared to the investment of a mortgage payment. You might just be tired of apartment living, with the neighbors playing loud music (or complaining about yours), or not having enough space for your dog or your kids to run around. Whatever the case may be, it’s likely that at some point in your life, you’ll be purchasing a home.

For most people, a home is the largest purchase they will ever make. A car is an expensive purchase, but it won’t likely go beyond $40,000 or $50,000, if that. A college education is expensive, but most likely won’t cost as much as a house. Buying a home is a big choice, and one that has to be considered very carefully. It’s a long term investment you are committing to, possibly for several decades. Most home buying consumers don’t have that kind of money offhand, so they will need to get a home loan.

There are other reasons people seek out the best mortgage lenders, and some of these people are already in a home. They may want a new mortgage to replace their current mortgage because the payments are too high or they don’t like the interest rate. They may want a mortgage to finance the purchase of a vacation home or pay for a large expense like a home renovation or college tuition. These current homeowners are also in the market for a mortgage.

What Is a Mortgage?

A mortgage is a loan to purchase a property. For most people, that means a home loan to purchase a primary residence. These types of homebuyers are most likely to get their mortgage from a retail lender like a bank, credit union, or online lender. To get a mortgage, a potential borrower will have to prove to the lender that they are not a credit risk and can responsibly pay back the loan. The bank will have its underwriting team or credit analysts make this determination. For some repackaged loans, a third party makes this assessment.

The lender will analyze the borrower’s income and compare it to their outstanding monthly expenses to determine if such a borrower could reasonably make their monthly mortgage payment. They will also look at the borrower’s personal credit history to determine their creditworthiness.

Another step in this process is the appraisal, which is often confused with a home inspection. A home inspection should be conducted on behalf of the home buyer, to make sure there are no serious structural issues with the home (like a leaking roof or cracked foundation). The home inspection may yield some talking points to negotiate the purchase price of the home, even if no major deal breakers are discovered.

As for the appraisal, this is conducted on behalf of the bank. The bank wants to know the true value of the home, one that reflects its actual condition and not just the market value or what the contract parties are willing to agree on. The reason the bank needs to know this information is that they do not want to loan more money than the home is worth. If the borrower defaults and the bank forecloses on the home, even if they liquidate the property they won’t be able to recoup their losses.

Sometimes, when an appraisal comes back, the contract has to be negotiated. Other times, it’s smooth sailing forward. Either way, if all the ducks are in a row, the bank is ready to extend a mortgage for the home purchase.

What Is a Mortgage Refinance?

A mortgage refinance, also called a refi or mortgage refi, is when you essentially trade your old mortgage for a new one. The bank issuing the refi will pay off your old mortgage, and you will now make your mortgage payments to the new lender. If you’re wondering why anyone would waste time going through such a process, it’s usually because the new lender can provide a better interest rate. Over several years, this different interest rate could yield tens of thousands of dollars in savings.

Even on a monthly basis, a refi could save you a significant amount of money. However, keep in mind that refinancing your mortgage will likely increase the number of mortgage payments.

For example, let’s say you initially had a 15-year mortgage and have 5 years left on it. You want to lower your monthly payment because money is tight. You may opt to refinance your mortgage debt with another 15-year mortgage. You can end up with a much lower monthly payment, but you must make this payment for 15 more years. Even though you almost had it paid off, the refi may offer much more affordable monthly payments that will allow you to pursue other goals or address other financial concerns.

Types of Mortgage Loans

There are several different types of mortgage loans. The mortgage loan that’s right for you depends on market conditions and your specific needs.

1. Conventional Mortgage

A conventional mortgage is not backed by the Federal Housing Administration, such as an FHA loan. Often, a conventional mortgage is also a conforming mortgage, which means that it meets the requirements set by Fannie Mae and Freddie Mac. These aren’t actual people, although they are often referred to by Fannie and Freddie. Rather, they are government-sponsored businesses that buy mortgages from banks and other similar lenders to resell on a secondary market of mortgage backed securities. One reason this is done is so that banks can issue more loans, thus stimulating housing purchases.

Conventional loans have limits that vary by location, but the average conforming loan limit for a single family home in most parts of the country is around $650,000.

Borrowers will typically need a credit score of at least 620 in order to secure a conventional mortgage. They will also need a DTI or debt to income ratio of 50% or lower. This ratio tracks how much of your income is used to pay off debt like credit cards, student loans, and car loans. If a potential borrower’s DTI is too high, the lender has good reason to believe that the borrower may default on the loan.

While it’s possible to get a conventional mortgage with a down payment as low as 3%, if a borrower puts down less than 20%, they will be required to get private mortgage insurance or PMI. This is a type of insurance that will protect the lender should the borrower default on the loan. Once you’ve paid off 20% of the loan, you can ask the lender to remove this PMI.

Conventional loans are going to most likely be the easiest path forward for homebuyers who have good credit, little debt, solid income, and who have enough money set aside to make a 20% down payment or more.

2. Adjustable-Rate Mortgage

An adjustable rate mortgage (also called variable rate mortgage) often has an initial period where the interest rate is locked into place, but then once that passes, the rate can fluctuate. This initial period is referred to as an ARM term, and it usually is set for 3, 5, 7, and 10-year periods. Once the ARM period is over, the interest rate will fluctuate in accordance with the index selected by your lender (which you agree to at the signing of the loan).

Contrary to popular belief, these mortgage rates do not all change with the Prime Rate set by the Federal Reserve, although some do. Other common causes of rate changes include the LIBOR, MTA, and the one-year treasury note.

Adjustable-rate mortgages can include an interest rate cap to prevent the interest rate from increasing beyond a certain point, but adjustable rate mortgages are still somewhat of a gamble. The rate can go down, but it can also go up. Even so, since the first part of the loan has a lower fixed rate, an ARM mortgage can be attractive to homebuyers who are confident they will either move, refinance, or pay off the loan quickly.

3. Fixed-Rate Mortgage

A fixed rate mortgage has interest rates that do not change. Unlike adjustable rate mortgages, these rates will not fluctuate, but stay the same throughout the life of the loan. There are two main types of fixed rate mortgages, and each one is named after the number of years in the loan terms.

The 30-year fixed rate mortgage is the most popular type of mortgage since consumers appreciate the predictability of fixed payments over several decades and the lower payment amounts.

The 15-year mortgage is more accelerated, but it may be preferential for homebuyers who want to get their mortgage paid off sooner, even if it means larger monthly payments. Alternatively, the 15-year mortgage is a common loan option when it comes to refinancing debt.

4. USDA Loan

A USDA loan is backed by the U.S. Department of Agriculture. Typically, the USDA is not the lender, although in some cases it might be. Backing the loan means that the USDA will repay a portion of it in case the borrower defaults. This motivates lenders to extend mortgages to certain buyers who would otherwise be considered a credit risk.

With a USDA loan, the borrower does not have to make a down payment, the interest rates are as low as 1%, and additional grants are available for improvements and upgrades.

Eligibility for a USDA loan depends on your state and your household income, however, most metropolitan areas do not qualify. The monthly mortgage payment must be 29% or less of the household income, with other monthly debt payments (car loan, credit cards, student loans) not exceeding 41%. If a potential borrower has a credit score of 640 or above, they will receive expedited processing. If potential borrowers are without decent, safe, or sanitary housing, they can also get expedited loan treatment. The USDA will issue direct loans themselves for properties under 2,000 square feet.

5. FHA Loan

An FHA loan is a mortgage that is backed by the Federal Housing Authority. This branch of the government repays lenders if a mortgage borrower defaults on the loan. This allows banks to lend money to a buyer with a lower credit score. Potential borrowers can make down payments as low as 3.5% and have credit scores as low as 500. The debt to income ratio is usually the same as a conventional loan.

Unlike a conventional loan, FHA loans require private mortgage insurance (PMI) for the life of the loan if your down payment is less than 10%. If it’s more than that, you are still required to carry PMI for 11 years, even if you acquire 20% equity in the home.

FHA loans have different loan limits: $420,860 in low-cost areas and $970,800 in more expensive real estate markets. You cannot use an FHA loan to buy an investment property or a vacation home – an FHA loan has to be used for your primary residence. However, you can use an FHA loan to purchase a duplex, triplex, or quadplex, and live in one unit as your primary residence while renting out the others.

FHA loans have a very streamlined refi process, making them an attractive loan option for a homeowner to reconsolidate a home loan. However, the appraisal process for an initial FHA loan is notoriously very strict. FHA loans are good for borrowers with poor credit or lower income who are unable to make a large down payment.

6. VA Loan

If you served in the United States military, you may qualify for a special loan that is only available to Veterans: the VA loan.

VA loans are not sold or serviced by the Department of Veterans Affairs. Rather, the VA financially backs these loans so that banks and other such lenders are willing to provide loans to veterans. VA loans typically have a lower interest rate, though one way that banks cover the credit risks of some applicants is by increasing the interest rate.

VA loans also do not require a down payment, which makes it significantly easier for veterans to purchase housing. There may be some closing costs like the VA funding fee that need to be paid, which is usually 2.3% of the loan amount. This funding fee can be rolled into the loan term instead of paid up front.

Additionally, a VA mortgage loan does not require PMI or private mortgage insurance on top of the monthly payment. This mortgage type offers some very favorable terms for eligible veterans in repayment for their service.

7. Jumbo Mortgage

If the price of the home you want to purchase exceeds the limits for conforming loans in your area, then you are going to need what is called a jumbo mortgage. A jumbo loan presents the borrower with a loan amount that can cover the purchase price of what is usually going to be a luxury home.

Many elements of the jumbo mortgage are the same as a conventional mortgage loan falling into the Fannie and Freddie limits. Some Jumbo mortgages may even have more competitive mortgage rates. However, they are certainly harder to get, because it’s a significantly larger loan amount. The loan officer will forward your financial information to the credit analysts, who will look at your credit report and any outstanding debts such as credit card debt, student loans, and perhaps other mortgages. You will most likely need a credit score of 700 or more.

8. Interest Only Mortgage

As odd as it might sound, an interest-only mortgage involves paying the monthly (or periodic) interest payment. The principal of the loan (the amount you are borrowing) is not paid off on a monthly basis. In some cases, it may be paid off in one lump sum at a certain date, which has led to this type of mortgage sometimes being referred to as a balloon mortgage.

This type of loan is best for a homeowner who will only be in their home for a short time and is confident that they will either have the money or be able to sell their home in time to repay the loan. Often, an interest-only loan is used by real estate investors who plan to purchase a property, renovate it, and put it back on the market right away.

9. Reverse Mortgage

A reverse mortgage is not as much a mortgage as it is a personal loan offered by the government, using your home as collateral. If you are 62 years old, you own at least 50% of your home, and the home on which you’re taking out the reverse mortgage is your primary residence (meaning, you live there for half the year), then you can take out a loan that is essentially equivalent to your home equity into cash.

The reverse mortgage was created to help seniors continue living in their homes, providing them with cash to pay for retirement expenses. However, many seniors, especially ones whose homes are fully paid off, have used the reverse mortgage as a financial tool to fund traveling or even the purchase of a vacation home.

10. Renovation Mortgage

A variety of home improvement loans are geared toward remodeling or renovating your home. One of the most common type of renovation mortgage is the home equity conversion loan, or HELOC (home equity line of credit).

A home equity loan is typically issued as a credit card that homeowners can use to pay for remodeling and all its expenses. The amount of money you can secure for the HELOC depends on how much equity you have in your home.

Some homeowners who want to remodel might opt to refinance their current mortgage. If the property value of their residence has increased (and it usually does), this extra amount can turn into some cash for remodeling.

There are also renovation loans available from the FHA, such as the Fannie Mae HomeStyle and FHA 203(k) loan. You can ask your bank if they offer such loans, and if not, find a lender who does. These loans do have down payments that range from 5-25%.

11. Bridge Loan

A bridge loan is a short-term financing solution that allows you to purchase a new home before you current home has sold. This type of loan is useful for homeowners who rely on the sale proceeds of their old home to finance their new one, but can’t do so until they sell. During a competitive housing market, buyers may want to make an offer on a new home quickly, and may not have time to wait for the sale of their current home.

Borrowers can take out a loan as they would with a second mortgage to secure the down payment for their new property. Or, they can take out a larger loan that pays off their current mortgage and provides extra funds for the down payment on their new home. The latter option requires a larger loan amount and more collateral to qualify.

Types of Home Loans

Whether you’re thinking about moving into your first home, second home, or getting a vacation home, there’s a type of mortgage out there for you. If you’re a veteran, there are special loans available. And if your income is lower than you’d like it to be, or you live in a rural area of the country, there are also special loans that can help you get into a home.

Mortgage loans can be helpful in a variety of ways. Some loans can be used for the renovation of your current residence. There are also opportunities to refinance your current mortgage with a better one that provides a better timeframe or lower monthly payment.

If you’re ready to make the jump into a mortgage, remember to do a little shopping around comparing rates and terms. Although a small percentage point may not seem like much, it can make a huge difference over the course of 15 or 30 years. A good loan officer will take the time to learn about your goals and then work within the limits of your personal finances to find the right type of mortgage loan for your home.