Time may be up on the home buyer tax credits, but you may hear “it’s still a great time to buy a home”. Why? Because interest rates on home loans are low and, most likely, have nowhere to go but up.
Smug home owners love to extol the virtues of buying, but you should never take the decision to buy a home lightly. Renting is not wasted money (especially if you’re investing what you’re saving).
That said, the current real estate and home loan market is enticing. Homes are cheap, and so are home loans. But before you commit to a debt that will likely take 15 to 30 years to repay, familiarize yourself with the basics of home loans.
A few years ago, any idiot could walk into a bank and walk out with a mortgage. Bad credit? There were subprime mortgages. Want more house than you could afford? Interest-only loans took care of that. Couldn’t prove your income? Mortgage brokers even wrote no documentation home loans. No down payment? No problem.
Today, most buyers have to get a home loan the old school way. That means good credit, a stable (and verifiable) income, and—with some exceptions like FHA loans—a fair-sized down payment. But what, exactly, are your options?
Good Home Loans
Fixed-rate mortgages are the simplest and most widely-available home loans. You can typically get fixed-rate mortgages for 30, 20, 15 or even 10 year terms.
To qualify, you’ll need a minimum credit score in the high six hundreds and a down payment of between five and twenty percent depending on things like your credit and your local housing market. If you don’t put twenty percent down, however, you’ll need to pay a bit extra every month for private mortgage insurance until you establish 20 percent equity in your home.
Personally, a fixed-rate mortgage is the only kind of home loan I would consider right now. The rate is guaranteed to stay the same for the life of the loan, so you’ll never be surprised by a higher monthly payment.
Adjustable-rate Mortgages (ARMs)
ARMs come in myriad varieties, some of them toxic. Two ARMs that aren’t always so bad are 5/1 year and 7/1 year ARMs. That means the interest rate will stay fixed for the first five or seven years of the loan and then adjust every year for the remaining life of the loan. These loans typically have lower interest rates and closing costs than fixed-rate loans, but carry the risk that interest rates will go up (and right now, they probably will). ARMs are quite attractive, however, to buyers who believe they will only live in their house for a few years.
So-So Home Loans
FHA Home Loans
The Federal Housing Administration (FHA) is a government agency that guarantees home loans, allowing mortgage lenders to offer loans to borrowers with lower credit scores and smaller down payments than they would ordinarily accept. Generally, borrowers with credit scores in the lower six hundreds can qualify for FHA loans with as little as a 3.5 percent down payment. The FHA caps on how much you can borrow depending on where you live and if you want to buy a condo, the building must be FHA-approved.
Although FHA loans provide a responsible path to home ownership for borrowers with modest incomes, credit scores, and savings, I put them in the so-so category because I simply think the 3.5 down payment required isn’t enough. I understand not everybody can save tens of thousands of dollars, but buying a home with so little equity and, most likely, little cash left in the tank for emergencies, is a risk I don’t recommend taking.
With the exception of a few pricey markets where the FHA has high borrowing limits, if you want to borrow more than $417,000, you’ll need a jumbo loan. It’s possible, but you’re going to need a mid-700s credit score and at least twenty percent down. Getting approved can be tricky and rates can vary widely among lenders, so it’s best to take the time to shop around for the best mortgage lenders for your needs.
Stupid Home Loans
Fortunately, most of the following home loans don’t exist anymore. That’s not to say, however, they won’t come back after banks’ institutional memories forget the mess these loans created in 2008. If you’re ever staring down an application for one of these loans…run.
Subprime basic ally refers to any home loans offered to buyers with crappy credit. If your credit is okay but not great, FHA loans are a good option. But if you can’t get approved for an FHA loan, don’t buy a home. Assuming you can afford a subprime mortgage’s lofty interest rate and keep up with your payments, owning a home just isn’t worth the cost of these loans.
Alt-A or No Doc Loans
So you’ve got good credit, but you can’t prove how much money you earn. Chances are, you’re going to have a difficult time getting a conventional mortgage. In the Wild West days of mortgage lending, banks might write what’s called an Alt-A or no documentation loan. In essence, they would charge you a little bit more but overlook the fact that you couldn’t perfectly document your income. If you’re truly a well-qualified home buyer with an odd source of income, chances are you can work with a bank to put together the docs you need for a traditional home loan, it may just take time.
The stupidest home loans out there are interest-only ARMs. These are loans that allow borrowers to make only interest payments for a certain amount of time. As long as you do, the principal of the loan doesn’t go down. These loans allow people to live in homes they simply could never otherwise afford. But why would anybody think that’s a good idea?
- In the market for a home loan? Understand the differences between pre-qualification vs. pre-approval or start the process by getting mortgage pre-approval online from competing lenders.