It isn't very often that you get to choose your home. So once you arrive…
All of us have some idea of what our perfect future looks like. Whether you are looking forward to building a family or carving a path for your career, one thing is for certain: we will all need a home that we can call our own. But choosing that ideal home is just half the journey. Part of the process is how you can turn that house over to your name without sacrificing the more important stuff in your life. For this reason, many people choose to finance their houses through home loans.
How Home Financing Works
Not everyone can afford to make a cash payment for a house, especially when you are in your early working years. When you need assistance in home financing, it’s time to learn about mortgage loans. If you’re only starting to research home loans, don’t worry because we’re going to make it more familiar to you!
To put it simply, a mortgage is a debt you decide to take on so you can pay for the purchase of the real estate. It might even just be for a vacation house, but most home loans will require that borrowers only apply for the purchase of a primary residence. This is ideal for first-time homebuyers who want to protect their liquidity while still growing their savings. Think of it this way, when you pay for a house in cash upfront, you are basically locking up those highly liquid funds to your home. If you don’t have enough savings put away for other needs, you might find yourself short in case of an emergency. As they say, cash is king, no matter how precious the alternate investment looks.
Buying a house via a mortgage automatically means that you will eventually be paying more than the original purchase price (seller’s asking price) of the home. There will be an interest included with your monthly payments, and most of the time, there is also mortgage insurance to think about. But it still beats the security you gain when you have the cash you can spend any time you need it. You can invest in home improvement or additional courses for your personal growth. It’s also tons better than simply paying rent to your landlord every month without any chance of gaining home equity.
Mortgages for Beginners
If it is your first time dipping in your toes in the business of applying for a mortgage, we’re here to help! Here are some essential topics that you absolutely need to read up on.
There are three primary types of government-insured loans: Federal Housing Administration (FHA) loans, U.S. Department of Veterans Affairs (VA) loans, and U.S. Department of Agriculture (USDA) loans.
Of the three, the most popular mortgage option is the FHA loan, since you have to be a military service member (or dependent) to qualify for a VA loan or be purchasing property in a rural area to avail a USDA loan. On the other hand, FHA loans serve to give opportunities to borrowers who live on low income and have poor credit ratings. Depending on your financial background, you might only have to put forward a down payment as low as 3.5% of the property purchase price to get financing through an FHA loan.
If the federal government does not ensure the home loan, this is called a conventional loan. This type of loan is usually recommended when you already have more savings put away and a thicker file on your financial history.
When you make a down payment of at least 20% of the purchase price, you can even forgo payment on private mortgage insurance completely, a benefit that many borrowers appreciate. Because unlike what the term might imply, private mortgage insurance does not actually insure the homeowners. Instead, it protects lenders in case borrowers stop making payments for their home loans. The theory is, when they have less than 20% home equity, there’s a higher chance for homeowners to default on their mortgage compared to when buyers already have a fifth of the purchase price payment secured.
There’s a reason why it’s important always to pay your bills on time. This helps you build a satisfactory credit history because when you apply for all kinds of loans, lenders will be doing a full financial background check on you. Even if you decide to avail of a government-backed mortgage, your credit score will need to be at least 500 (for FHA loans) to qualify. On the other hand, conventional loan lenders will ask for a credit score of at least 620 to approve your mortgage application. These numbers are the basic minimum that your financial background must show on paper before you apply.
Debt to Income Ratio
Another factor that lenders look at that might help you get approved for a home loan is your debt to income ratio. They are concerned with this because they want to make sure that you will have enough money every month to pay your loan. Suffice it to say, the more existing debt you have on a limited income, the more unattractive you will look to the lender. To improve your debt to income ratio, do your best to pay off other loans before applying for a mortgage.
As we have mentioned, there’s no escaping paying a monthly interest rate on the money you have borrowed. Home loans are either fixed-rate mortgages or adjustable-rate mortgages. With a fixed rate, you don’t have to anticipate any changes when you make your monthly payment. Meanwhile, with an adjustable-rate mortgage, it’s the other way around. Your monthly payment amount changes according to the prevailing interest rate that depends on the economy’s direction.
Tips for First-Time Buyers
1 – Beef up savings
A home purchase is a serious decision that one does not make on a regular. While there are indeed many loan options to choose from that can ease the burden of paying a transaction this large, it will definitely help if you can arrive at this scenario with more money to spend. Simply having more money saved in the bank will help you become eligible for more benefits and leverage the home loan negotiation. A bigger down payment can mean a low-interest rate awarded and a free pass on mortgage insurance. It can also boost your credit score that will make it easier for the home loan process to close.
2 – Check your credit report
This is important, especially if you plan on getting a conventional loan. Lenders for these loans tend to be stricter when it comes to requirements, and you cannot risk any erroneous entries in your report that might hinder you from qualifying. It might seem like a nightmare, but it truly does happen. Congress tasked the Federal Trade Commission to conduct a study on this, and they found that at least 5% of borrowers have had mistakes in their credit reports that may have barred them from much-needed loans. The good news is, it is a problem that can be fixed. You can read on here to find out how to dispute errors on your report.
3 – Shop around for a lender
Although it might seem like you have more to gain from the transaction than the party lending you money, you have to remember that home loans are still financial products. You will only be bringing more business to the bank or lender, who will decide to approve your mortgage application. Don’t be afraid to negotiate with the lender to understand that you will be a paying customer they need to woo. Be one of the 53% of people who take the time to compare their options. You might be qualified for a low-interest rate or low down payment at the next lender if only you’d cared to check!
4 – Find a first-time homebuyers assistance program
There’s one in almost every state! As the name implies, this kind of program seeks to make the whole business of applying for a home loan easier for buyers. You can get a better deal on closing costs and end up with greater home equity. Depending on the state where you will be purchasing your home, you might even get credits for your tax return. Some professionals can also get an edge for financing, especially teachers and military service members.
5 – Get a preapproval letter
Before you actually comb the market for your ideal home, it’s better if you have already spoken with a lender. A mortgage preapproval contains the loan amount that the lending institution has determined you are qualified to borrow. This can be a good bargaining chip to bring to the real estate negotiating table when you can prove to the home seller that you have the capacity to make payment for the sale. Having a preapproval letter in hand can also give you a good idea of the existing offers that will dictate your buying options. You don’t want to get heartbroken after finding your dream home, only to learn that you will not secure financing for the cost.
The journey for a home purchase is an exciting adventure that happens only once in a while. Keep this in mind as you surf the market for the best deals and programs that will help you along the way.
As long as you make sure that all of your choices are made of informed decisions, there’s no reason for you to encounter any surprises further down the road. If you make it a habit always to analyze costs and make payments on time, you’re already halfway ahead of most!