Looking to buy a home? Congratulations! Owning a home is an incredible experience as well as one that offers so much more freedom than lending. However, the process of buying a home can be a perilous one, especially when shopping for mortgage loans. There are many different kinds of loans to choose from as well as many different lenders. What is the best way to choose between them all? Reading below will certainly help!
What is a Mortgage Loan?
A mortgage loan is a loan issued primarily for the purchase of a primary residence. Or, to put more simply, to buy a home! Homes can be tens, if not hundreds, of thousands of dollars, and without mortgage loans being available, most Americans would never be able to buy their own home.
However, before you start the process of applying for mortgages and beginning the process of buying a home, you need to be sure your finances are in order. There are a few key things that you can do to prepare yourself to make the mortgage application process as simple as possible.
Key actions to take before applying for a mortgage loan
- Check your credit score
- Save for a down payment
- Prepare for additional fees
This is one of the single most important actions you can take before applying for a mortgage loan. Your credit score is one of the key factors that determine your "creditworthiness," or your ability to take on debt and your reliability to pay it back. A score of at least 620 will qualify you for most types of mortgages and will help secure the best interest rates.
Though there are mortgage types that do not require a down payment, you may or may not qualify for those programs. Unless using the VA loan program, you need to plan on at least a 3.5% down payment of the base loan. If using a conventional loan, you may need to save as high as a 20% down payment, depending on your creditworthiness.
Even if your credit score is great and you saved for a down payment, you will need money for various fees. These include closing costs, upfront mortgage insurance payments, and more, which can total thousands of dollars. Many loan types allow you to roll these fees into the mortgage itself, but you still need to have money ready to handle any fees that may come up in the mortgage process.
Where can I get a mortgage?
There are a lot of different places you can apply for a mortgage. Banks, credit unions, and even in-house real-estate lenders can all walk you through the process of applying, and being approved, for a mortgage. Shopping around for the best rates is key, however, as different lending entities will offer different rates.
You want to find a lender that can meet your specific needs. Here are some characteristics to consider when shopping for a lender and a mortgage:
- What kind of loan am I shopping for?
- How does the lender determine creditworthiness?
- How do I want to interact with the lender?
There are FHA mortgages, VA mortgages, conventional mortgages and more. You want to be sure to find a lender that specializes in the specific kind of loan you are shopping for.
Not all lenders will use a credit score or debt-to-income ratio to determine your ability to take on a loan. Some look at factors like consistent rent payments (which generally do not show up on a credit score). Others may be willing to look at more recent financial gains (like a promotion or a raise) that have not been present on a tax return yet. If you have a weak credit score but otherwise strong finances, look for a lender who can accommodate your situation.
Lenders can be entirely online with no human interaction, while others are brick and mortar locations or even a mix of the two. If you have a preference of how you communicate with your potential lender, that will impact the kind of lenders available to you.
What kind of mortgage loans are there?
There are a lot of different kinds of mortgage loans to choose from, but on this list, we will focus on the three most prominent loan types, as well as some base qualifications and benefits. Not all mortgage types are available to all borrowers, so take note of any special requirements they may have.
- FHA Loans
- VA Loans
- Conventional Loan
An FHA (or Federal Housing Authority) Loan is a type of loan that is guaranteed by the federal government. Since the risk of lending is mitigated by the government, you have the option of low-interest rates, a 3.5% down payment, and lax credit requirements. You will be required to have mortgage insurance, which adds to your monthly mortgage payment. This type of loan is popular with low-income borrowers, bad credit borrowers, and first-time home buyers.
A VA loan is a loan program offered by the Department of Veteran Affairs exclusively for past and current service members. This loan program requires no down payment, offers low-interest rates, and has flexible credit and financial requirements. It also avoids the requirement of having mortgage insurance, though you will have a one-time fee that is based on your loan amount and specific military service.
The conventional loan is the loan made available to most borrowers seeking to buy a home. It is available through a number of lenders, like banks and credit unions. It requires at least a 3% down payment (and as high as 20%), and a favorable credit score of at least 620.
That's just a brief overview of mortgages. If you want more detailed information or are interested in potentially starting the process of applying for a mortgage, reach out to a mortgage professional! They can be found at your local bank, credit union, and even through online lenders. They are your best bet to easily walk through the process of applying for a mortgage!
FHA Loans
There can be a lot of roadblocks to buying your own home. Saving money for a downpayment can be difficult. Your credit score might be a limiting factor in qualifying for a favorable interest rate or even being approved for a loan at all. However, there is a special federal backed loan that caters specifically to low-income citizens: the Federal Housing Administration Loan!
What is a Federal Housing Administration (FHA) Loan?
An FHA loan is a special government-backed loan that is designed for those with low to moderate-income levels. They require a small down-payment (as low as 3.5% of the total loan) and are available to potential borrowers with bad credit. If you have at least a 580, you will potentially be qualified!
If your credit score is below 580, you still have some options to work within the FHA. If you can put down a 10% down-payment, your credit can be as low as 500 and still potentially qualify for this loan.
What requirements come with an FHA Loan?
The requirements may sound fantastic, but the trade-off of having such lax requirements to qualify for an FHA loan is having several requirements to meet while holding an FHA loan.
First, an FHA loan is a loan from a traditional lender that is guaranteed by the federal government. Because of that, there are a couple of insurance items that you will need to pay to use an FHA loan. The first is the Upfront Mortgage Insurance Premium (UFMIP), as well as an annual MIP.
UFMIP
When you pay this fee, it is set aside in an escrow account to be used in the event you foreclose on your mortgage. The fee will help continue to pay the mortgage on your behalf. How much the UFMIP is 1.75% of the loan you are borrowing. The more your loan is, the higher this fee will be.
MIP
The other MIP is worked into your monthly mortgage, and the rate can vary. Generally, you can expect it to be 0.85% of the loan each year, Again, this is not charged to you in a lump sum, Instead, it is worked into your monthly mortgage payment.
The MIP is not necessarily a permanent insurance fee you have to pay. How long you have to pay depends on the length of the loan. In general, you will either be required to pay the fee for 11 years or for the life of the loan.
If those fees and restrictions sound like more than you want to deal with, you can always opt for a conventional loan. Generally, an FHA loan will appeal to those who are low-income, have a poor credit score, or are first-time home buyers, if being used to purchase a home.
How does an FHA loan compare to a conventional loan?
An easy way to think about it is that a conventional loan is harder to get but less expensive to manage in the long run. Whereas an FHA loan is easier to get but, because of fees like the MIP, will end up costing you more in the long run. Here are a few key differences with more detail.
- Credit Score: You can qualify for an FHA loan with a credit score as low as 500. With a conventional loan, you will want at least a 620 and higher if you want the best interest rate.
- Down Payment: With an FHA loan, you are looking at either a 3.5% downpayment or 10% downpayment (depending on your credit score). A conventional loan can have down payments as low as 3%, but they can be as high as 20%. It is generally best to try to make a large down payment, as that saves you money in interest in the long run.
- Mortgage Insurance: Remember how you are stuck with this extra cost with an FHA? With a conventional loan, if you can put down 20%, you do not have to have it at all!
- Lender Options: With a conventional loan, you can borrow from essentially any institution that will approve you for a loan. If you are using an FHA loan, the institution will need to be an FHA certified lender.
Once you have already purchased your first home, you are generally set up to be able to use conventional loans well. Also, if you have great credit or high income, you may not need to consider an FHA loan at all. If you are a first-time homebuyer, low-income, or have bad credit, an FHA loan remains a viable alternative to get you into your own home.
What can I use an FHA Loan for?
There are five unique kinds of FHA loans that can be used, each appealing to their segment of potential borrowers. They are:
- Traditional Mortgage: This is what most people will use an FHA loan for. They will receive the loan and use it to buy a home!
- Home Equity Conversion Mortgage: As opposed to first-time homebuyers, this kind of FHA loan is geared more towards senior citizens. It is essentially a reverse mortgage that is guaranteed by the federal government. A reverse mortgage is when a lender allows borrowers to exchange their home equity in exchange for cash.
- 203(k) and Energy Efficient Mortgage Program: Want to get your house as environmentally friendly as possible? This FHA loan is what you are looking for! It includes extra cash for making home-improvements geared specifically at keeping down utility costs, like air-conditioning or heat.
- Section 245(a) Loan: This is most likely not a loan you will get, though it is an option. To make it simple, it is a loan that slowly increases your mortgage payments from month to month (for example, if you were expecting to be employed, get a raise or promotion in a specific time frame). This ends up allowing you to pay the mortgage off more quickly than you otherwise would.
An FHA loan is a great way for many borrowers to be able to own their own home without the limitations of a conventional loan. However, an FHA loan is not for everyone, so be sure carefully consider your needs or talk to a mortgage expert to get the perfect home loan!
VA Loans
A VA loan is a benefit made exclusively to those who currently are or have served in the US military. They offer great interest rates, lower fees, and several other benefits that make the process of buying a home simpler. Interested in a VA loan? You have come to the right place to learn about it!
What is a VA Loan?
A VA loan is one that is at least partially guaranteed by the Department of Veteran's Affairs (that is where the "VA" portion comes from). This allows lenders to offer VA loans with more favorable interest rates, loans that do not require a down payment, more flexible credit and income requirements, and fewer fees than a conventional or FHA loan.
If you are seeking to take advantage of the VA loan program, you will not face a barrier to how much you are allowed to borrow (outside of your creditworthiness, of course). However, a home loan under the VA program will not necessarily be completely guaranteed by the federal government.
Also, though you can use the program more than once, certain benefits are limited. For example, the amount the VA will guarantee (or entitlements) has a fixed amount based on where you live, and certain fees increase after the first time use of the program.
How do I qualify for a VA Loan?
To take advantage of the VA loan program, you will need to be a part of the U.S. military. Almost all service members will eventually be eligible to participate in this program, though there are restrictions. If you meet one of the following, you should be eligible for a VA loan:
- If you were active service during wartime for 90 consecutive days.
- If you were active service during peacetime for a total of 181 days.
- If you were or have been an active member of either the National Guard or Reserves for at least 6 years
- If your spouse died in the line of duty or directly from a service-related injury.
If you meet any one of those requirements, you are in luck! You can take advantage of VA loans. However, just because you qualify for the loan program does not mean that you have qualified for a loan. Though, in general, you can get approved with lower income and lower credit scores, you still have to have your creditworthiness evaluated by a lender.
How does a VA Loan compare to an FHA Loan?
An FHA Loan (or Federal Housing Authority Loan) is another loan program backed by the federal government. However, the costs and benefits of these loans differ greatly. In general, if you qualify for a VA loan, it will almost always be the better option of the two.
- Credit Score: The FHA loan has lower credit requirements than a VA loan. Your credit score can be as low as 500 and you can still qualify for an FHA loan. A VA loan, though the credit requirements are laxer than a conventional loan, is still higher (usually around 600)
- Down Payment: This is where a VA loan shines. It does not require any down payment at all (this is due to funds called "entitlements" that are guaranteed by the federal government. With an FHA loan, your down payment will be 3.5% or 10% of the base loan, depending on your credit score.
- Mortgage Insurance: This is, again, another place where a VA loan is advantageous. You do not have to have any mortgage insurance at all through the VA loan program. With an FHA loan, you will be required to have an upfront insurance fee as well as an annual insurance fee. Depending on your down payment, you can opt-out of mortgage insurance on an FHA within 11 years.
Again, both loan programs can allow many people to own homes that conventional loans may not be able to help. It bears repeating, if you qualify for a VA loan, it is almost always the better option than an FHA loan.
What fees are associated with VA Loans?
With VA loans, you can avoid a lot of costs and fees that other borrowers might face. This includes mortgage insurance, down payments, and other closing costs. However, VA loans are not without their special costs.
VA borrowers will have a one-time fee that varies depending on both how much you can put towards a down payment as well as how you specifically served and if you have used the program before.
For borrowers who have never used the program and are not using a down payment, your fee will be 2.15% of the base loan. If you can offer at least a 10% down payment, that fee gets reduced to 1.25%.
There are more variables as well. If you were active service, your fee will generally be less than if you were in the National Guard or the Reserves (usually by around .25%). You can also use the program more than once (though certain benefits, like entitlements, are limited). If you are using the program for the second time without using a downpayment, your one-time fee will be 3.3% of the base loan amount.
What lenders can work with a VA loan?
You will want to work with lenders that have a specialty in dealing with VA loans. These loans come with their unique requirements and regulations and a misstep from a potential lender can cause serious problems. If you're unsure if a lender has a specialty in VA loans, simply ask!
As you can see, the VA loan program is an amazing loan program available to past and present service members. No down payment, low interest, reduced fees, and flexible financial requirements make this loan program one of the best available. If you think you may qualify, reach out to a specialized lender today and they will guide you through the steps of navigating not only the VA loan process but the home buying process in general.
