What are the basic types of loans I should know about?
Here is a brief run-down of four major mortgage plans:
A conventional loan is a loan made to a buyer without a third-party participant, such as VA or FHA. Fixed-rate conventional loans are typically paid off in equal monthly payments spread over 15, 20, or 30 years. The interest rate stays the same for the life of the loan; therefore the monthly principal and interest payment remains constant. Shorter terms mean somewhat higher monthly payments. Shorter terms also mean more rapid equity growth, mortgage pay-off and dramatic savings on total interest payments.
Terms of a conventional loan vary among lenders, but many can be obtained with as little as 5-10% down payment. When the down payment is less than 20% it is necessary to obtain private mortgage insurance (PMI) to protect the lender from a buyer's default.
Advantage: Quick processing and stable payments.
Adjustable-Rate Mortgage (ARM; also "variable
The interest rate may go up or down over the years and is tied to a financial market index (such as one-year Treasury bills). Monthly payments may also be adjusted on a periodic schedule. Most ARMs set a maximum adjustment (or "cap") on possible increases to interest rates, monthly payments, and/or a maximum cap on rates for the life of the loan.
Advantage: The lower initial interest rate and monthly payment allows the buyer to pay less in the early years for a larger loan and help buyers qualify for a more expensive house than with a fixed-rate loan. Caps offer peace-of-mind rate ceilings.
Strictly speaking, FHA does not make loans; rather it insures loans, which increases lenders' willingness to make low down payment loans.
With an FHA-insured loan, a home buyer can make a small down payment, a feature particularly attractive to first-time buyers. The down payment can be as low as 2.25 percent, depending on the size of the loan. Second mortgages are permitted within specific guidelines.
Points (prepaid interest) can be charged by the lender. The purchaser may negotiate the interest rate and points with the seller. FHA buyers of single-family homes can finance 100% of closing costs.
FHA charges an advance mortgage insurance premium (MIP) fee, as well as, a monthly charge for all loans. Ask an agent how much the fee would be in your situation, and if you can borrow some of the fee and add it to the loan rather than measurably increasing your closing costs.
FHA-insured mortgages offer a maximum loan amount that varies area to area.
Advantage: Low down payment; low interest rates; long terms; many are fully assumable loans; no prepayment penalty; second mortgage permitted under certain circumstances.
Qualified veterans can take out loans up to a specific limit with no down payment. These limits occasionally change; check with an agent for current rules. VA-guaranteed loans can be combined with second mortgages and are fully assumable by any qualified buyer. Rates and points may be negotiated with the lender.
VA/FHA qualification guidelines are more flexible than those for conventional loans. Actual income qualifications are dependent on the type of loan requested.
Advantage: Usually no down payment; points can be paid only by the seller, although the buyer is charged a loan origination fee (tax deductible); no prepayment penalty; assumption may make your home very attractive to buyers when you decide to sell. thing.