Buying a home is a major life accomplishment, but there are a few basics you need to know before making your first purchase. Your bank account might be properly cushioned, but personal savings aren’t the only thing that counts. Unless you’re purchasing a property in all cash, you need to understand your financing options for paying for your new home. If you’re an aspiring, first-time homeowner, read through this beginner’s financing guide to make your purchasing experience stress-free.
So many loans, so little knowledge
Most first-time buyers need to take out a loan to purchase their new property, but the amount of loans to choose from can be dizzying. Learn about the different types of mortgage loans and find the structure that’s best for you.
- Conventional Loans
A conventional loan has a fixed-rate mortgage, and they are neither insured nor guaranteed by the federal government. Fixed-rates are appealing, but they’re difficult to qualify for due to strict approval criteria such as down payment, credit score, and income.
- FHA Loans
The Federal Housing Administration (FHA) is a branch of the U.S. Department of Housing and Urban Development and provides various mortgage loan programs. FHA loans are ideal for first-time home buyers because they’re easier to qualify for and require less of a down payment. While FHA loans offer many benefits, they include drawbacks in the form of mortgage insurance and minimum property standards.
- VA Loans
The U.S. Department of Veteran Affairs (VA) allows veterans and service people to obtain VA loans on favorable terms. The VA does not issue these loans directly, but guarantees these mortgages through qualified lenders. If you’ve served, be sure to request a certificate of eligibility from the VA before applying for a loan.
- Hard Money Loans
A hard money loan is a specific type of asset-based loan financing through which a borrower receives funds secured by real property. These are typically issued by private investors or companies, and are a way to borrow without using traditional lenders. They’re fast and flexible, but you might end up paying a premium for the convenience. Hard money rehab loans are great for under-esteemed properties that you plan to renovate yourself.
Equity and Income Requirements
Once you know which loan you want to pursue, understand how the lender will determine the pricing of your mortgage. In addition to checking your FICO credit score, will refer to two additional statistics to set the rate charged on your loan:
- Loan to Value Ratio (LTV)
LTV is a comparison between the value of your loan and the value of your home. View it as mortgage loan balance divided by home value. The higher the LTV, the greater the risk, because it suggests the asset behind the loan is less likely to be paid off as the ratio increases. In this case, you might be required to purchase mortgage insurance.
- Debt-service Coverage Ratio (DSCR)
DSCR is the measure of cash flow available to pay debt obligations. In general, it’s calculated by dividing an individual’s net operating income by the total debt service. DSCR is one of the main ways a lender will determine the terms of your loan and whether or not you qualify.
Stable or Stationary Rates
When shopping for loans, pay attention to the rate structures and see what’s best for your situation.
- Fixed-Rate Mortgage
A fixed-rate mortgage is one where the rate does not change for the entire period of the loan. The benefit here is knowing what the monthly loan costs will be for the entire loan lifespan.
- Floating-rate Mortgage
These are designed to assist first-time home buyers or people who expect their incomes to rise over the period of the loan. They allow borrows to obtain lower introductory rates, but pose a risk for those whose income does not grow in step with changes in interest rates.
While this list is not all-encompassing, it’s a great springboard into your research for home financing. Loan types, interest rates, equity, and income are essential concepts you need to understand before entering the buyer’s market. Start with this guide to feel more confident about your home-buying journey.