Buying a home can be one of the most exciting (and costly) purchases you will make during your lifetime. One of the most important steps in the process is determining how much you can afford. Yet, many people wait to secure financing until it is absolutely necessary. In a competitive housing market, having your financing in place before you start your home search gives you the ability to place an offer immediately after viewing the home of your dreams, and to make that offer stronger, which is a must these days! It also allows you to focus on the more enjoyable decisions, like choosing a neighborhood.
PRE-QUALIFICATION VS. PRE-APPROVAL
Pre-qualification and pre-approval are two common words thrown around in the mortgage industry. Pre-qualification is an unofficial estimate of how much you can borrow and repay for your home purchase. The amount lending institutions will pre-qualify you for is derived from the information you provide on your finances, credit history, and income. Obtaining pre-approval requires you to submit financial documents, such as tax returns, business licensing, and bank statements. Lenders will analyze the documents, run credit checks, and verify employment. The pre-approval process verifies you have the ability to repay the amount for which you are approved and carries more weight when you submit an offer to purchase a home. Although it takes more steps to obtain pre-approval, it verifies to the seller that you have the financing available to follow through with the purchase. It also allows you to close the loan within two to three weeks of going under contract. This gives you a competitive edge against other financed offers, everything else being equal.
TYPES OF FINANCING AVAILABLE
There are numerous financing options available to home buyers and it is important to have a basic understanding when interviewing mortgage lenders. The mortgage lender you choose will help you decide on the best product available that will meet your mortgage needs. Here are some the most popular mortgage loans:
Fixed rate (Conventional)
Sometimes referred to as a conventional loan, this loan has a fixed interest rate over the entire loan period. The loan period can range from 15-40 years. Longer loan terms can help make for a lower payment, but interest paid over the life of the loan will be greater. These loans encompass nearly 70% of all home loans made each year. The major advantage is a fixed payment every month over the life of the loan, which protects against rising interest rates.
Adjustable Rate Mortgage has an interest rate that is periodically adjusted, based on an index that changes with the prevailing market rates. Usually, the adjustments are specified in the loan documents and can have yearly adjustment caps as well as minimum and maximum lifetime limits on the interest rate.
These are loans that are meant for first time home buyers and low to moderate income families. They are guaranteed by the Federal Housing Administration. FHA loans allow for smaller down payments, lower closing costs, and easier qualification requirements. The Federal Housing Administration determines the maximum amount available to borrow for each county based on the median home price. Ask your lender what those limits are if you are considering an FHA loan.
The United States Department of Veterans Affairs loan program ensures all veterans are given an opportunity to purchase a home. To qualify, you must have served actively in the military or been a spouse of someone who has served. VA loans allow for fixed rate terms that are competitive with conventional mortgage rates.
A Balloon loan is a loan that is structured like a fixed rate loan, but has a shorter term period that isn’t fully amortized (paying off of debt in regular installments over a period of time). After the loan term period, the outstanding balance is due in a balloon payment.
This is a loan that has interest only payments for an initial set period. During this period, the principal balance remains unchanged. When the interest only period expires, the loan then becomes fully amortized over the remaining period of the loan. The longer the interest only period, the steeper the jump when the principle and interest payments begin.
Portfolio mortgages are usually issued by small to medium sized banks and are funded and kept in the bank’s investment “portfolio.” These loans aren’t sold on the secondary market and don’t have to comply with Fannie Mae or Freddie Mac lending requirements. They have a distinct advantage over traditional mortgages because they make their own lending rules. It allows the borrower to purchase a unique property that doesn’t meet the guidelines for conventional financing (non-warrantable condo, HOA litigation, etc.). It also allows for more liberal borrow requirements that could disqualify borrowers from traditional financing.
As you can see, there is a lot to the financing side of a home purchase. Starting the process early (or even really early) allows you to dial in and focus on searching for homes, which is the best part!