Buying a home is a significant milestone that many aspire to reach. When contemplating whether it’s the right time to move forward with the home-buying process, the most important factor to consider is finances. However, navigating the world of mortgages is daunting, and with terms like FHA, conventional, interest rates, ARM, etc. being thrown out, it only overwhelms the average homebuyer. In this article, I wanted to demystify the financing experience and empower you to make informed decisions by breaking down the major financing options and making it digestible for anyone.
How Does a Mortgage Work?
First and foremost, let’s break down what a mortgage is and how it works. At its core, a mortgage is a loan provided by financial institutions that help you buy a home. Put simply, the bank will give you the money required to buy the property, and you will then pay back the bank over a certain timeframe, often being 15 or 30 years, in addition to interest, which is a set percentage that the bank charges over each year as a fee for lending you the money.
The process typically begins with a “pre-approval”, where you submit documents to the financial institution showing your current financial situation to allow them to determine the loan amount you qualify for. Some major factors that play into them determining the loan amount are income, debt, and your credit score. Once pre-approved, you can start house hunting with confidence, knowing your budget and financing options.
Down Payment
Another factor determining your loan is what’s called a “down payment.” Your down payment is how much money you are paying out of pocket when you buy a home. For example, if you are buying a $500,000 home, and you put a down payment of 20%, you will pay $100,000 up front, and the bank will lend you the remaining $400,000 that you will pay off over the loan term. The down payment is important as the more you put down, the less you are borrowing from the bank and the less your monthly payment is. A good financial institution will be able to help you determine how much you should put down to fit your lifestyle and budget, and there’s different programs that allow you to put down different amounts of money to make buying a home more affordable up front.
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FHA Loans and Conventional Loans
An FHA loan is a term that is thrown around a lot when talking about homeownership. Put simply, an FHA loan is a government-backed mortgage that was designed to make homeownership more accessible, particularly for first-time buyers. These loans are insured by the Federal Housing Administration which allows lenders to offer better terms such as a lower down payment or more flexible credit requirements. Therefore, they are a very viable option for prospective homebuyers who may be more limited in the funds they have to put down, and is definitely something you should ask your lender about, as you may be able to put down as little as 3.5% of the sale price towards buying a home.
On the other hand, conventional loans are not backed by the government and typically require higher credit scores and larger down payments. They are a common option for those who have the funds to put more down and want to avoid private mortgage insurance, and for those who do not qualify for an FHA loan.
Of course, these are not even close to the only two mortgage solutions out there, but by understanding these two, you will have a foundation to understand the two most talked about options and can build your knowledge from there.
Banks vs. Brokers
When it comes to obtaining a mortgage, you have the option of working directly with a financial institution or hiring a mortgage broker. Banks, such as Bank of America or Chase, offer their own wide range of loan products and provide personalized service to existing customers, whereas brokers act as intermediaries between borrowers and multiple lenders to help you find the best mortgage rates and terms. Both are great options, and it’s recommended to shop multiple places when looking for a mortgage to find the best terms and offers possible for yourself.
Final Thoughts
Buying a home is a significant investment that requires careful consideration and a thought out strategy. By understanding how a mortgage works, you can take the first steps towards homeownership with confidence by starting your research with a foundation of knowledge to base off of and find a mortgage solution that aligns with your goals and needs. But of course, this is all surface level information, and it is vital to speak to a lending professional to have a catered experience when finding a mortgage solution.
