What is a Mortgage?
If you’re in the market for a house but don’t have the savings to pay for the entire property with cash, you can get a residential mortgage to cover the difference between your down payment and the sale price of the house.
A residential mortgage is a common legal agreement in which an individual borrows money from a bank or person to buy property such as a house or a condominium. A mortgage agreement typically states that the borrower must repay the borrowed money and any interest to the lender on a predetermined schedule. Should the borrower fail to pay per the contractual schedule, the lender typically has a legal right to take possession of or foreclose on the property, which is the security for the loan. Below you’ll find definitions of loan types for some of the most common mortgages available.
Fixed-rate mortgages are the safest bet if you always want to know what you owe. Generally repaid over a period of 15, 20 or 30 years, the interest rate and monthly payments of principal and interest for fixed-rate mortgages are locked in for the duration of the loan. If you can secure a fixed-rate mortgage, you limit the volatility of your loan and know exactly what your payment will be for the lifetime of the loan.
Adjustable-Rate Mortgage (ARM)
Also known as variable rate or tracker mortgages, adjustable rate mortgages are designed to adjust to match the market after an initial fixed rate period. For instance, a 5/1 arm will start to adjust to an index such as the one-year Treasury or the Cost of Funds Index after a five-year period at a fixed loan rate. ARM loans can be appealing because they are often packaged with low initial rates, but once the rates adjust they can potentially cause dramatic and unpredictable swings in mortgage payments that are difficult to budget for.
If you expect your income to improve over time and are bullish on the real estate market and your ability to match a growing mortgage payment in the future or refinance, interest-only loans can be a good option. In the initial five- or ten-year period of the loan, the borrower only pays interest – no principal – meaning a smaller overall mortgage payment. At the end of the interest-only period, either a balloon payment for the balance of the mortgage principal may be due or the payments may increase to pay off the principal within the remaining period of the loan.
Private financing, also referred to as private money, can be a good option for people who have been through bankruptcy, foreclosure or other financial troubles and are looking to buy a house. This is a financing method where a company or individual person may provide a mortgage loan to a non-conforming residential buyer who does not qualify for a bank loan. These typically are considered high risk and therefore are likely to carry higher interest rates especially if the loans are high-risk. They are also largely unregulated. Lenders are required to comply with lending laws at the state and local level but not necessarily with banking regulations.
Seller Carryback and Hard Money Loan
Another option for properties that don’t qualify for traditional bank financing but have a potential buyer with enough cash for a down payment, seller carryback and hard money loans are possible options for advancing a residential property sale. A seller carryback is when the seller of a property finances a percentage of a loan. Hard money loan is when a mortgage is designed to cover just the loan-to-value ratio on a property. Typically, a down payment or some other kind of collateral is required from the borrower to secure this type of loan.
Only available to eligible service members who meet specific requirements, home loans from the Department of Veterans Affairs are popular among those who qualify as they require no down payment. Additionally, there are limits on lender feeds such as closing, origination and appraisal fees. No private mortgage insurance (PMI) is required to secure VA loans, even if service members opt not to provide a down payment.
The Federal Housing Administration, a division of HUD, insures some types of loans to make homeownership more accessible through lower down payments and closing costs along with more flexible credit requirements. If you are buying a first home or a fixer-upper, you may be eligible for an FHA insured loan. The FHA also provides reverse mortgages for senior citizens who have paid off most of their mortgage and want to turn their home equity into cash for living expenses.
This is only the beginning! There are many other loan types for mortgages, including jumbo loans, second mortgages, reverse mortgages and rural development services loans.
For more information on how to shop for loans and understand your rights as a homebuyer, visit HUD.gov, the website of the Federal Housing Administration.