Are you tired of renting and thinking of buying a house? Are you confused about the different types of home loans available in the market?
Buying your own home is an important life decision, one that can affect you financially for many years to come. It is essential to understand all loan options before making this big commitment. Home loans are the most popular medium to purchase a new house and there are various types available in the current market.
In this article, we’ll discuss some of the common types of home loans available to potential buyers. We’ll go over typical features and requirements as well as how much you can expect from each type.
Fixed-rate mortgage loan:
A fixed-rate mortgage loan is a type of home loan where the interest rate remains the same for the entire term of the loan, typically 15 or 30 years. This means that the borrower’s monthly payments will not change, making it easier to budget and plan for the future. The interest rate on a fixed-rate mortgage is typically higher than on an adjustable-rate mortgage, but the borrower has the peace of mind of knowing that their payments will not increase.
Adjustable-rate mortgage loan:
An adjustable-rate mortgage (ARM) loan is a type of home loan where the interest rate can change over time, typically every year or every few years. The interest rate on an adjustable-rate mortgage is typically lower than on a fixed-rate mortgage at the beginning of the loan term, but it can increase or decrease based on market conditions. This means that the borrower’s monthly payments can also change, making it more difficult to budget and plan for the future. ARMs are often referred to as “variable-rate mortgages” or “floating-rate mortgages.” They are best suited for borrowers who plan to own the home for a short period of time and expect interest rates to decrease over the life of the loan.
Conventional loan:
A conventional loan is a type of mortgage loan that is not insured or guaranteed by the government. These loans are typically offered by private financial institutions such as banks, credit unions and mortgage companies. Conventional loans are available in both fixed-rate and adjustable-rate options. They are called conventional loans because they conform to the standards set by Fannie Mae and Freddie Mac, which are government-sponsored enterprises that buy and securitize mortgages. The terms and requirements for conventional loans are generally more stringent than for government-backed loans, such as FHA loans and VA loans. Conventional loans typically require a higher credit score and a larger down payment.
Jumbo Loans:
A jumbo loan, also known as a non-conforming loan, is a type of mortgage loan that exceeds the limits set by government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac. These limits vary by location and are generally around $510,400 for a single-family home, although they can be higher in certain high-cost areas. Because jumbo loans exceed these limits, they are considered to be higher risk for the lender and typically require a higher credit score, a larger down payment, and a higher interest rate than a conventional loan. Jumbo loans are typically used to finance luxury homes, high-end properties, or investment properties. They can also be used to refinance existing mortgages that have exceeded the limits set by the GSEs.
Government Insured Loans:
Government-insured loans are mortgages that are insured or guaranteed by a government agency. The most common government-insured loans are the Federal Housing Administration (FHA) loan, the Veterans Affairs (VA) loan, and the U.S. Department of Agriculture (USDA) loan.
- FHA loans are designed to make homeownership more affordable for first-time homebuyers, low- to moderate-income borrowers, and those with less-than-perfect credit. These loans are insured by the Federal Housing Administration and require a lower down payment and credit score than conventional loans.
- VA loans are available to active-duty military members, veterans, and eligible surviving spouses. These loans are backed by the U.S. Department of Veterans Affairs and offer attractive benefits such as no down payment and no mortgage insurance requirements.
- USDA loans are intended for low- to moderate-income borrowers who want to purchase a home in a rural or suburban area. These loans are backed by the U.S. Department of Agriculture and offer no down payment and low mortgage insurance requirements.
All government-insured loans have some restrictions and guidelines to follow. However, they are less strict than conventional loans and they are a good option for the people who meet the criteria and have trouble getting approved for a conventional loan.
Interest Only Mortgage:
An interest-only mortgage can be a useful option for some borrowers, particularly those who expect their income to increase significantly in the near future, or those who plan to sell the property before the interest-only period ends. The advantage of an interest-only mortgage is that the borrower’s monthly payments will be lower during the interest-only period, which can make it easier to afford the home.
However, it also comes with some disadvantages. One of the main disadvantages is that the borrower will not be building any equity in the property during the interest-only period, which means that if the property value decreases, the borrower could end up owing more than the property is worth. Additionally, when the interest-only period ends, the borrower will be required to start paying both the interest and the principal, which can result in a significant increase in the monthly payments. This increase in the payment could be too much for the borrower to handle, leading to default and foreclosure.
Interest-only mortgages are often considered as high-risk loan, therefore, they are typically offered to borrowers with good credit and high incomes. It’s always important to consult a professional financial advisor or mortgage broker before deciding on an interest-only mortgage to understand the terms and conditions that come with it.
Home Equity Loans:
A home equity loan, also known as a second mortgage, is a type of loan that allows homeowners to borrow money using the equity in their home as collateral. The equity in a home is the difference between the current market value of the property and the outstanding balance on the mortgage. For example, if a home is worth $500,000 and the outstanding mortgage balance is $300,000, the equity in the home is $200,000.
Home equity loans can be a good option for homeowners who need to borrow a large sum of money and have built up enough equity in their home. These loans typically have lower interest rates than unsecured loans, such as personal loans or credit cards, because the lender has the added security of the borrower’s home as collateral. Additionally, the interest paid on a home equity loan may be tax-deductible, which can make it a more attractive option than other types of loans.
The loan amount for a home equity loan is typically based on the amount of equity that the borrower has in their home. Lenders will typically approve loans for up to 80% to 85% of the home’s value, minus the outstanding mortgage balance. For example, if a home is worth $500,000 and the outstanding mortgage balance is $300,000, the borrower could potentially borrow up to $120,000 to $127,500.
Home equity loans have a fixed interest rate and a fixed repayment period, which means that the borrower will make the same payment each month for the life of the loan. These loans are typically paid off over a period of 5 to 15 years. It’s important to note that if a borrower defaults on a home equity loan, the lender has the right to foreclose on the property, which means that the property can be sold to repay the loan.
Balloon mortgages:
Balloon mortgages are often used by individuals or businesses that need a short-term loan and expect to have the means to pay off the loan within a few years. They are popular with real estate investors because the lower monthly payments make it possible for them to purchase properties that they might not be able to afford with a traditional mortgage.
However, because the balloon payment is so large, these loans can be risky for borrowers who are not able to pay it off. If a borrower is unable to refinance or sell the property before the balloon payment is due, they may be forced to default on the loan.
Due to the risk and uncertainly they pose, many lenders have stopped offering them. The one that do, tend to require a higher credit score, and also a larger down payment as well as proof of income, to mitigate the risk of defaults
It is important to consider all the pros and cons before opting for a balloon mortgage, and make sure you have a plan in place to pay off the balloon payment when it comes due.
