Getting a mortgage is an important financial decision. It’s also one of the most complex consumer transactions you will ever make. Your choice of loan type, lender, and other factors can affect your total cost for years to come.
But it doesn’t have to be complicated if you know what to do and how to avoid common mistakes. The following information should help answer some basic questions about buying a home with a mortgage loan in the USA.
What is a mortgage?
A mortgage loan is an agreement to borrow money secured by real property (real estate). When you buy a house with a conventional mortgage or any other type of private or government-backed lending instrument, the property serves as collateral for the lender.
If you default on your monthly payments, they can take back the house and sell it to get their money back.
It’s basically where you borrow money from a bank or other lending institution to purchase a property.
How do mortgages work in the USA?
When it comes to mortgage loans in the US, there are many types to choose from. Some loans are more advantageous than others, but most of them require certain underwriting guidelines of the lending institution.
These guidelines are regarding your credit history and collateral (i.e., what you’re borrowing the money against).
Mortgage loans are treated as commercial papers in the USA. It means they are;
- Typically stated in an amortized format.
- Have a variable interest rate (and therefore payments).
- And come with prepayment penalty fees if you pay off the loan before its closing date.
The purpose of this system is to clear the mortgage loan from the system as quickly as possible.
Types of US mortgages
There are several different types of mortgages in the USA. Each of them has its unique benefits and drawbacks, making it more or less attractive to different people.
1. Fixed-Rate:
A fixed-rate mortgage guarantees the interest rate on your loan for a specific period, typically 15 to 30 years. Once you secure this type of loan, there’s no way to increase or decrease your monthly payment unless through prepayment or an extension of the term.
Fixed-rate mortgages are often the most attractive option if you plan to live in their homes for an extended time and can afford a higher monthly payment. However, they typically require a larger down payment (20% – 30%) than other types of loans.
2. Jumbo Mortgage:
This is a fixed-rate mortgage for people looking to borrow more than Fannie Mae and Freddie Mac allow. The jumbo loan market can be complicated, so you should work with an experienced lender when applying for this type of loan.
Jumbos typically come with higher interest rates because they’re considered to be riskier than conventional loans. You should expect to pay a higher down payment (typically 25%). Also, you will need a credit score of 700 to qualify for one.
3. Adjustable Rate Mortgage (ARM):
ARMs are fixed-rate mortgages that can change about an index and margin specific to your loan (this can vary from lender to lender). The interest rate and monthly payments will fluctuate as the index changes.
However, this type of loan typically has a lower initial interest rate than that of a fixed-rate mortgage, so your monthly payments will be lower as well.
In most cases, an adjustable-rate mortgage is a good choice for people who don’t plan to stay in their homes very long and want to save as much as they can on their monthly payments.
4. FHA Mortgage:
An FHA loan is Federal Housing Administration (FHA) backed mortgage loan. It comes with several benefits, including a low down payment requirement (as little as 3.5%) and the possibility to roll closing costs into your loan.
These loans also tend to be more lenient when it comes to credit requirements and debt-to-income ratios.
However, some drawbacks come with an FHA loan, including a slightly higher interest rate than conventional mortgages. Also, it’s more expensive to get an FHA loan because you will have to pay for mortgage insurance.
5. USDA Loan
A USDA loan is a mortgage that the Department of Agriculture insures. A USDA home loan may be an attractive option for you if you live in an area where it’s challenging to qualify for other types of conventional loans.
This type of loan is similar to an FHA loan because there’s a low down payment requirement (as little as 3%) and lenient credit and debt standards.
However, like an FHA loan, there’s a higher interest rate associated with this type of mortgage and the extra costs that come with it (mortgage insurance). Also, you’ll need to make sure that your home is in an area where USDA loans are available.
6. VA Mortgage
Veterans Affairs or VA loans are mortgages that the Department of Veterans Affairs ensures. These are attractive options for veterans looking to get a home loan without having to make a down payment.
Additionally, you can qualify with little to no money down if you’re willing to pay an upfront funding fee (2.15% of the loan). After that, you will be able to finance 100% of your home.
7. Conventional Mortgage
Conventional loans are not insured by a government agency and don’t have as many requirements as FHA or VA loans. With these mortgages, you can put down as little as 3% on a home purchase or refinance.
There are no fees for these loans, but the interest rate is usually higher than when it comes to FHA and VA loans. Also, your credit score needs to be at least 620 to qualify for one of these types of mortgages.
8. Interest Only Mortgage
An interest-only mortgage is a type of home loan that gives you the option to make only interest payments for a set period (typically 5 or 10 years).
This is an ideal choice if you want to wait until your salary grows before making higher monthly payments. Also, this type of mortgage typically has lower monthly payments than it would with a conventional fixed-rate mortgage.
However, when the period ends, your monthly payments will be higher. Additionally, you will have to pay for mortgage insurance if your down payment is less than 20%.
How do you qualify for a US mortgage?
Several factors go into qualifying for a mortgage in the USA. However, the requirements depend on what type of loan you’re trying to get and who the lender is.
There are some common factors that lenders look at when you’re applying for a mortgage:
1. Your credit score: Generally, the higher your score, the better. The minimum credit score requirements vary depending on what kind of loan you’re applying for. The standard range for FHA and VA loans is 500-579, but you’ll need a score of at least 620 with conventional or USDA loans.
2. Your debt-to-income ratio: This factors in your ability to repay the loan based on your income and recurring expenses (like mortgage payments, utilities, credit card bills). Generally, lenders want your debt-to-income ratio to meet or be below 43%.
3. Employment history: As part of qualifying for a mortgage in the USA, you’ll need to prove that you have a steady source of income and employment history.
4. Down payment: This is the upfront cost you pay when purchasing a home. Lenders expect to see at least 5% of your overall loan amount.
5. Monthly housing expenses: This includes taxes and insurance, homeowners association fees, etc.
6. Cash reserves: Lenders expect you to have a certain amount of saving money that would be available if you need to make an unplanned purchase or expense.
Conclusion
There are several different types of mortgage loans in the USA. Each one has its own sets of requirements and guidelines that you need to consider when applying for a mortgage.
Mortgage loans in the USA are pretty standard, but you’ll need to go through a bit of paperwork before you can get approved. The best idea would be to hire a qualified mortgage lender to help you through the process.
