New Home Loans for the First-Time Homebuyer

Home Loans: An Overview

There are many types of loans for today's home buyers to consider. The following provides an overview of some of the more common options.

Fixed Rate Mortgage or Adjustable Rate Mortgage

While these are both options to consider, Fixed Rate Mortgages have been gaining in popularity in recent months. A Fixed Rate Mortgage allows the homeowner to retain the interest rate they begin with, for the whole life of the loan. With interest rates so low now, the idea of keeping the starting rate is very enticing.

Adjustable Rate Mortgages allow the homeowner to begin the loan with an introductory mortgage rate that is lower than the rate offered to Fixed Rate Mortgages. Periodically, throughout the loan, this rate adjusts, bringing it in line with whatever the going rate is at the time, based upon a particular index such as England's LIBOR rate. This can be appealing to homeowners who plan an re-selling or re-financing the house in a few years, or who are very confident that their income will rise significantly.

100% Financing:  0% Down Loans

There is such a thing as 100% financing - with no money down. Of course, closing costs may still apply, and the interest costs are higher in this type of loan. But for those with little saved up for a home, but with a strong interest in home ownership, this options is available, depending on credit scores, debt-to-income ratios, and other factors. For a more thoughough analysis of the advantages, disadvantages, read the full article about 100% Financing / Zero Down Payment Mortgages.

How to Avoid Mortgage Insurance: 80/10/10 Financing

If you purchase your home with less than 20% down, chances are you will obtain a loan that is insured by "Mortgage Insurance" (MI). Private mortgage insurance or MI is a type of insurance provided by a private mortgage insurance company to protect a lender in the event of default on a loan. This type of insurance is generally required when a borrower has less than 20% equity in a home; i.e. the loan amount divided by the property value is 80.01% or greater. As your home appreciates or your loan balance decreases (or a combination of the two), and your equity in the home exceeds 20%, you may petition the mortgage holder to drop the MI. This process may be cumbersome or difficult.

One way to avoid paying MI is to purchase a home with a combination first and second mortgage. The first mortgage would be limited to 80% of the home's appraised value. The second mortgage, which would close in conjunction with the first, would then provide for the difference between the home's purchase price, less the 80% first mortgage, less the down payment available . In other words, if you have a 10% down payment available, your first loan would provide for the 80% mortgage with a second mortgage of 10%. This is commonly referred to as an 80 -10 -10 transaction.

Another way to avoid incurring MI payments is to find a lender that offers self-insured programs. This type of loan would have a higher interest rate in place of the private mortgage insurance premium. While mortgage insurance premium payments are not tax deductible, the interest associated with a self-insured mortgage would be fully tax deductible.

The decision of whether to obtain a loan with mortgage insurance versus the above two options should take into account the combined total monthly payments of the various options, adjusted for the tax benefits of interest deductions.  

No Cost Purchases

This does not mean the home is free. It means there are no closing costs. This is available to some homebuyers, if the borrower's credit score, debt-to-income ratio and other factors are strong, but the borrower has limited funds available for closing. This type of loan may also be considered when the interest rates are declining and the borrower may want to refinance quickly, though there is no way to predict the market and interest rates with much certainty. No closing cost loans can also be used effectively to free up more cash for the down payment or save for repairs or other uses. However, what is essentially happening is that the closing costs are being rolled into the loan amount, meaning the closing costs are being financed, which increases the amount of interest the homeowner will pay over the life of the loan. Also, by increasing the loan amount, this decreases the homeowner's equity. This is why this option is not considered standard. In some circumstances, however, it makes perfect sense.

In some extreme cases, no closing cost loans can allow the homeowner to borrower more cash than is needed for the direct closing costs. As long as this does not exceed the lender's guidelines (typically 3% of the purchase price in overall credits), this cash can be applied to other costs in the transaction. One important item to remember is that a no closing cost loan will not have points, and thus no deduction for that cost. Additionally, the other costs are paid for and no deduction is available. If you are purchasing a home, points and some costs are generally entirely deductible in the year you buy. This is true even if the seller is paying for your points. 

Purchase Pre-Approvals

A purchase preapproval is a lender's analysis of a borrower without specific property information. In other words, your loan information is submitted to a lender for full underwriting and includes all borrower details, such as employment information, asset information, and credit history. The lender then approves you as a borrower, subject to a maximum loan amount, down payment, and interest rate. This is not the same as Prequalifying. Pre-approval goes a step beyond that.

Getting preapproved for a loan is critical in today's real estate environment. Many Realtors do not want to accept offers from buyers unless their home loan has already been approved by a lender.  By going through the loan process prior to being in contract on a home, you can eliminate all of the obstacles to borrowing without jeopardizing an actual purchase transaction. Once your loan is approved, your real loan closing will be quick and subject only to a satisfactory appraisal and title report on the home.

To begin the preapproval process you need to make some assumptions for your purchase price, loan amount, and loan program. Any of these assumptions can change once you've found your home, but it helps to do the following:
  1. Complete your application for the maximum loan amount and purchase price that you're interested in. You can always reduce these later.    
  2. Get your loan approved at an interest rate that is higher than what you expect to take. Again, the loan program that you decide upon can differ from what you are initially approved at.
The preapproval of your loan will ensure that your real purchase will go smoothly once you have located the perfect home.  

No Income Documentation Loans

These loan types are harder to come by since the subprime crises, when it was discovered that this type of loan had been abused in some ways, and because of that, they posed a higher risk to lenders than had been anticpated. But with stricter guidelines now in place, No Income Documentation Loans can still be obtained in the right circumstances.

Often grouped together despite their subtle differences, "light documentation," "no-income verification" and "quick qualifier," or "QQ" loans are a solution for many buyers who have income from sources that are hard to verify. Usually these loans are used by self-employed borrowers who have difficulty verifying all of their income, or by borrowers with very complex income structures. For example, a borrower who has income primarily from rental properties and investments may be hesitant to verify all sources of income due to the volumes of paperwork this would require. With a no income documentation loan, the borrower can simply state his income on the application, and the lender will use this stated income to qualify the loan. When lenders do this, they charge a higher rate of interest to help cover the additional risk. Lenders do in fact rely on verifying that the borrower has assets that logically match the stated income, along with excellent credit.

With a higher cash down payment, typically 25% or higher, along with good credit, these loans allow borrowers to buy into purchase prices a lender wouldn't ordinarily qualify them for. Because no-income documentation loans carry a higher interest rate, they should only be used when necessary, not simply to avoid the paperwork requirements of a full documentation loan.

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