Mortgage basics: What you should know about home loans
Having a mortgage is the best type of good debt that you can have. It is also is also excellent tool for building wealth.
Here’s what you need to know about home loans:
Mortgage fact: A wide variety of loan types are available.
The most common type of mortgage is known in industry jargon as the conventional, conforming loan. This type of mortgage is issued by a bank or mortgage lender and then resold to Fannie Mae or Freddie Mac, the giant companies that keep the home loan market humming. These loans are typically for amounts of less than $550,000, and they are extended to borrowers with stellar credit.
A number of other loan types are available as well. The Federal Housing Administration (FHA) backs loans to borrowers with as little as 3.5 percent down, and with credit scores in the low 600s. The U.S. Department of Veterans Affairs (VA) also runs a loan program with no down payment required and no minimum credit score. While FHA and VA loans are a good way to become a homeowner, these loans also carry steep fees.
Other options include jumbo loans for borrowers who need more than the Freddie and Fannie limits. For most parts of the U.S., the jumbo loan cutoff in 2021 is $548,250. However, that limit rises to $822,375 in pricey housing markets, including much of California and New York City.
If you’re a self-employed borrower, you might need something known as a “non-QM” loan. While business owners and independent contractors can and do qualify for conventional loans, the hurdles are a bit high for many.
Mortgage fact: You don’t need 20% down – but you’ll pay a premium.
To qualify for a mortgage, you need not make a 20% down payment. FHA and VA loans let borrowers put down far less, and even loans backed by Fannie and Freddie are available with down payments as low as 3%.
There’s a downside, however: FHA and VA loans carry hefty fees to offset the higher risk of lending to borrowers with little skin in the game. For Fannie and Freddie loans, you’ll pay private mortgage insurance, coverage that protects not you but the lender in case of default.
Mortgage fact: Shopping around will get you a better deal.
The U.S. Consumer Financial Protection Bureau and Freddie Mac have issued studies showing consumers reap significant savings by comparing at least three mortgage offers. That’s because rates and closing costs can vary from lender to lender.
Mortgage fact: Your credit score matters – a lot.
Lenders generally extend the best rates to borrowers with credit scores of 740 and higher. So if you’re shopping for a mortgage, make sure your credit score is as high as you can reasonably make it.
Other factors can affect your rate, too – including your debt-to-income ratio and your loan-to-equity ratio. And if you’ve suffered a job loss or an interruption in income, lenders are unlikely to issue you a mortgage at all.
Mortgage fact: Refinancing can be a costly exercise.
Refinancing can be a smart move when rates fall. However, you’ll pay thousands of dollars for the privilege. The tab for refinancing a $300,000 loan easily can hit $9,000. So if you’re refinancing simply to lower your rate, make sure the monthly savings will offset the closing costs within a few years.
Mortgage advice: Don’t worry about paying down your mortgage.
Too many homeowners are trying too hard to pay down their mortgage debt, either by making extra payments or by shortening the terms of their loans. You’re better off borrowing against your home and devoting the money to your investment accounts. This approach will generate more wealth over the long run.
Mortgage lenders offer terms of 20, 15 and 10 years. Don’t bother. The best move is to stick with a 30-year loan, and to borrow as much as you can against your home at the cheapest cost possible. That typically means borrowing 80% of your home’s value, so you can avoid private mortgage insurance while also maximizing your leverage.
How may I help you?