As an intending home buyer, the first thing you need to know is that financing is the most vital aspect of acquiring a property. It might interest you to know that in the US, about 42% of homes are financed by mortgages. This figure serves as a source of hope to many buyers who do not have the financial means to purchase a property.
If you are looking to get a home soon, this article will help you understand the most common types of home loans and give you some insight into which might be best suited for your needs.
How Do Mortgage Loans Work?
A mortgage loan is a sum of money that a homebuyer will borrow from a lender (such as a bank or credit union) to finance the money needed to buy a house.
The mortgage market is divided into two basic categories: the primary and the secondary mortgage market. The primary mortgage market allows homebuyers to borrow mortgage loans directly from primary lenders such as banks, mortgage brokers, mortgage bankers, and credit unions.
The secondary mortgage market, on the other hand, is a large market with several participants where mortgage loans and servicing rights are bought and sold by various entities. Some of the participants involved include investors, mortgage originators, mortgage aggregators, and securities brokers.
How Credit Scores Impact Obtaining a Mortgage Loan
One factor that markedly influences your chances of obtaining a mortgage loan is your credit score.
Many lenders use credit scores to measure the risk involved in lending people money. Typically, a high credit score implies low risk, while a low credit score implies high risk.
This implies that the higher your credit score is, the more likely you are to get easy approvals, lower down payments, and favorable interest rates, and vice versa.
Credit scores below 580 are generally considered to be low, while credit scores of 700 and above are considered high.
Take, for example, a buyer with a high credit score of 760 who gets a 30-year, fixed-rate mortgage for $200,000. With this credit score, he or she might get a low interest rate of 3.612%.
At this rate, the monthly payment would be $910.64, and the buyer ends up paying $127,830 in interest over 30 years.
However, with a lower credit score of 635, the interest rate will likely be high at perhaps 5.201%, which might seem negligible until the numbers are added up.
The buyer’s monthly payment is $1,098.35, which is an extra $187.71 monthly and the total interest for the loan is $195,406, of which an additional $67,576 has been added.
What is a Conventional Home Loan?
The conventional home loan is the most common mortgage type available to buyers. This type of home loan is not financed by any government agency but is made available through private lenders such as banks and mortgage companies.
It is important to note that the conventional mortgage has strict rules that guide its lending system hence, not everyone qualifies to obtain it. To be a well-qualified buyer, one must have a solid financial foundation evidenced by:
- A credit score of 620 and above
- A down payment of at least 20%. Lenders may accept less than 20% however, borrowers would be required to take out private mortgage insurance and pay its premiums monthly until they achieve at least 20% equity in the house.
- A verifiable income for at least 2 years
- An acceptable Debt-to-income (DTI) ratio of 43% or less.
Once an investor has met the listed criteria, he or she is required to fill out an official mortgage application, pay the necessary fees and then supply the lender with the necessary documents to conduct a thorough check on their background, credit history, and current credit score.
Benefits of a Conventional Home Loan
Here are the great benefits of a conventional home loan for home buyers:
- They require less paperwork than government-backed loans, thus taking less time to be finalized
- They are more diverse and provide buyers with more loan options to suit their specific needs
- They can be used for all kinds of property
- They are usually at a fixed rate, implying that borrowers’ periodic payments remain the same, whether interest rates climb or housing prices fall.
What is an FHA Home Loan?
An FHA home loan is a government-backed home loan insured by the Federal Housing Administration and issued by an approved lender such as a bank.
This type of mortgage is popular amongst first-time buyers and low-to-moderate-income earners because it is specially developed to help applicants with low financial standing.
FHA loans require a lower minimum down payment than several conventional loans and applicants may have lower credit scores than are typically required.
However, borrowers are required to pay FHA mortgage insurance, which is put in place to protect the lender from a loss in case the borrower defaults. This insurance premium is approximately 1.75% of the total loan amount.
To qualify for an FHA home loan, home buyers must meet the lending requirements guiding an FHA mortgage. These requirements include:
- A credit score of 500 to 579 with a 10% down payment, or a credit score of 580 or more with a 3.5% down payment
- Verifiable employment history for at least 2 years
- A stable income that can be verified through federal tax returns and bank statements
- The loan must be used to finance a primary residence
- The property must be appraised by an FHA-approved appraiser and must meet HUD guidelines
- Borrowers must wait at least 1-2 years after bankruptcy and 3 years after a foreclosure before applying for the loan.
Benefits of an FHA Home Loan
Here are the great benefits of an FHA home loan for home buyers:
- They are government secured hence, this translates to less-strict requirements for qualification
- Buyers with low credit scores can qualify for FHA loans unlike conventional mortgages which require buyers to have a solid financial position
- They allow buyers to make lower down payments than conventional home loans
- Borrowers do not have to wait for long periods after a major credit event such as bankruptcy or foreclosures before applying for a loan
- They provide buyers with affordable mortgage insurance when compared to conventional mortgages.
What is a VA Home Loan?
A VA loan is a mortgage option available through a program established by the U.S. Department of Veterans Affairs (VA). It enables veterans, service members, and their surviving spouses to purchase homes with little to no down payment, no private mortgage insurance, and get competitive interest rates.
While the U.S Department of Veterans Affairs sets the qualifying standards, decides the terms of the mortgages offered and backs the loan, they do not offer the financing. Instead, approved private lenders, such as banks and mortgage companies, provide the loans.
To qualify for a VA home loan, here are the criteria that must be met by home buyers:
- The buyer must be a veteran, an active-duty service member, a member of the National Guard, a reserve, or the surviving spouse of a veteran
- The borrower must meet the minimum active-duty service requirement depending on where they served
- The buyer must possess a Certificate of Eligibility (COE) from the U.S Department of Veterans Affairs
- Verifiable employment history for at least 2 years.
Benefits of a VA Home Loan
Here are the great benefits of a VA home loan for home buyers:
- They have flexible and generous guiding rules, unlike other types of home loans
- No fixed credit score is required. The only credit criterion is for the borrower to be considered a satisfactory credit risk by a lender
- No down payment is required unless requested by the lender, or if the residence’s purchase price is above the established property value
- There is no private mortgage insurance requirement
- Closing costs are limited and may be paid by the seller
- There is no prepayment penalty if the borrower pays off the loan early
- Assistance is available from the VA to help borrowers avoid default.
Mortgage Loans with Bad Credit
According to most lenders, a FICO credit score of 580 or less is considered poor or bad credit and the buyer has a minimal chance of getting a mortgage. However, this does not automatically mean you can not qualify for mortgage loans as there are several loan options and mortgage lenders who cater to buyers with poor credit scores.
Some of these options include:
Secured Personal Loans
A secured personal loan is a loan that is backed by collateral. This means that the borrower must pledge an asset or collateral to obtain the loan. There are several kinds of secured loans for bad credit, including mortgages, auto loans, and home equity loans.
Unsecured Personal Loans
An unsecured personal loan is a loan that does not require the borrower to pledge any asset or collateral to obtain a loan. This is the most common type of loan option available for bad credit. Lenders who offer unsecured personal loans include banks, credit unions, and some online lenders. The repayment terms of unsecured loans typically range from two to seven years.
Final Thoughts on Home Loans
While funding is an essential part of acquiring a home, it is also an aspect that confuses a lot of buyers. As an intending buyer, you should carry out thorough research on each home loan option available to you before making a choice. It might also help to consult with a professional, such as a real estate agent.
