For most home buyers, especially first time home buyers, shopping for a home can be stressful and confusing. Many times the most confusing part of the home buying process is understanding the different types of loan options that are available. Here is an overview of the most common loans buyers use to purchase real estate.
Conventional loans are loans that use Fannie Mae and Freddie Mac guidelines in order to make the loans conform with respect to Loan to Value (LTV), borrower credit scores, borrower income requirements and minimum down payment amount. Conventional loans allow a minimum down payment of 5% and are generally utilized by home buyers with excellent credit. Mortgage origination fees with conventional loans are less than government insured loans like FHA and VA loans. Conventional loans allow the home buyer to receive a seller's assist ranging from 3% -6% of the purchase price depending on down payment amount.
FHA Loans are loans backed by The Federal Housing Administration (FHA), a part of the U.S. Department of Housing and Urban Development (HUD). FHA does not lend money but rather insures the loan against default by the borrower. Since the disappearance of the no money down loans FHA loans have become increasingly popular because their 3.5% down payment requirement is the lowest of all loans currently available to most home buyers. FHA loans are generally utilized by home buyers who cannot qualify for conventional mortgages because FHA loans offer more flexibility with respect to down payment amount, credit score, debt to income (DTI) ratio and other important loan qualification variables. FHA loans charge an upfront mortgage insurance premium (MIP) which makes FHA loans origination fees significantly greater than conventional loans.
VA Loans are available to borrowers who are serving or served in a branch of the US Military. VA home loans are overseen by the U.S. Department of Veterans Affairs and allow the home buyer the opportunity to purchase a home with no money down (100% financing!) provided 1) the home appraises and 2) the seller pays all closing costs. There is no PMI on VA loans but the VA charges an upfront VA funding fee which can be rolled into the closing costs. Veterans seeking to purchase a home with a VA loan must still prove sufficient income, credit and cash reserves.
An adjustable rate mortgage or ARM, also called variable rate mortgages, is a loan where the interest rate is not fixed but instead varies periodically. Interest rates on ARMs are usually linked to an index, like the LIBOR, and rates vary to reflect to the cost to the lender of borrowing money in the current credit market.
Home Equity Loan
A home equity loan is a loan where the borrower uses the equity in their home as collateral for repayment of the loan. Home equity loans are often used to finance major expenses like home renovations, unforeseen medical bills or children's college education. A home equity loan creates a lien against the borrower's house, and reduces the homeowner's equity in the home.
Home Equity Line Of Credit (HELOC)
A home equity line of credit, also called a HELOC, is a loan for a set amount that is secured by the borrowers existing equity in the home. HELOCs differ from home equity loans in that the borrower does not necessarily receive the entire loan amount up front but instead uses a line of credit to borrow amounts that do not exceed the set credit limit. Money can be borrowed using HELOCs during the draw period which can be anywhere from 5 to 25 years and the monthly repayment minimum is usually a small, interest only payment. The full principal amount of the loan, sometimes called a balloon payment, is due at the end of the draw period.