Home Financing 101
Once you’ve decided to buy a home, you’ll need to decide how much you can afford, and what type of loan you might qualify for. It’s easy to find a home affordability calculator online, which will ask for your annual income and proposed down payment. Although there are many variables, as a general rule, your monthly mortgage payment plus any other housing costs (association fees, etc) should not exceed 35-40% of your gross monthly income. Some loans you might consider:
Conventional loans are fixed rate mortgages that are not insured by the federal government (although some conventional loans comply with guidelines set forward by Fannie Mae and Freddie Mac). Conventional loans used to be difficult to qualify for, but now you can apply with as little as 5% for your down payment, although it still helps to have a strong annual income and above average credit score.
FHA loans are guaranteed by the Federal Housing Administration, part of the US Department of Housing and Urban Development. They are easier to qualify for and great for first-time home buyers. FHA loans allow down payments as low as 3.5%.
VA loans are guaranteed by the US Department of Veteran Affairs and available for veterans and military service members. They offer favorable rates, don’t require a down payment, and ask for easier credit and income qualifications.
Although less common, the US Department of Agriculture also offers Rural Housing loans: zero down payment mortgages for eligible rural homebuyers.
A construction loan is a short-term interim loan to cover the cost of building a new home, and is usually designed to be dispersed over time directly to the builder. These loans might be combined with loans that cover the cost of buying land and the eventual mortgage of the house.
You’ll need to know a few more important terms. If you can’t provide a 20% down payment, you’ll have to pay PMI – private mortgage insurance. PMI protects the lender from losing money if you default on the loan, and usually amounts to between .3% and 1.5% of the original loan amount per year. Once your outstanding loan balance drops below 78% of the original value, your lender will cancel the PMI. However, recent FHA loans have required insurance over the life of the loan, and can’t be canceled (but, you can refinance).
Fixed-rate mortgages have a fixed interest rate over the life of the loan. With an adjustable-rate mortgage (or ARM), the interest rate applied on the outstanding balance varies – sometimes annually or even monthly – depending on a broader measure of interest rates, called an index.
Lastly, mortgages will usually be offered as 30-year loans or 15-year loans. The monthly payment with a 15-year loan will be substantially higher, but the overall interest paid will be significantly lower.