The path to owning a home can be both exciting and overwhelming. Whether you have found your forever home, the right home for right now, or the perfect income property, taking out a home loan may be the necessary next step to owning that ideal location. But how do home loans work? What steps do you need to take? With a variety of loan options available, it may seem difficult to navigate which loan is the best option for your particular situation. However, understanding these various loans’ basics will give you the necessary tools to get you into your new home. Let’s explore these loans and how they work together.
Understanding A Mortgage
Before outlining the particulars of the loan, you first have to understand what a home loan is. A mortgage is an agreement between the borrower and the lender. These loans can be obtained through credit unions, banks, or mortgage loan companies. The lender helps finance the purchase of a property under agreed terms, consisting of a loan with interest. Ownership of the house is subject to making these payments according to the terms outlined.
If you default on your loan, the lender has the right to sell the property. Once the loan is entirely paid off, ownership is transferred from the lender to the borrower.
Steps To Getting A Mortgage
Though there are several types of home loans available, the process of obtaining one is the same. So how do home loans work? The first step is pre-approval. Pre-approval helps the lender understand your financial situation, including your credit score and current debt. This will determine the amount the lender allows you to borrow and help you set a realistic budget.
If you have been approved for a loan, you must fill out the necessary documents, including the promissory note, the mortgage paperwork, and possibly a deed of trust. The promissory note outlines the terms and conditions of repayment, while the mortgage allows the lender to take ownership of the property if you fail to make payments and default on the terms of the promissory note. The deed of trust allows a trustee (a third person) to be added to the mortgage along with the lender and borrower.
Once you have found your dream home and an offer has been accepted, the purchase agreement is sent back to the lender for review. If approved, your loan will go through the underwriting process. Your income, employment history, and assets will be verified against your credit report. During this time, your lender will arrange for an appraisal and home inspection. If everything checks out, you can begin closing once the underwriting process is complete.
You will need to pay the down payment and any other closing costs. Once you have made these payments and signed the mortgage, you take possession of the deed and your new home.
Fixed-Rate Loan Vs. Adjustable-Rate Mortgage
Now that you have a basic understanding of how home loans work, it’s essential to understand the differences in available loans. You can select from a fixed-rate mortgage or an adjustable-rate mortgage (ARM).
A fixed-rate mortgage has a set interest rate that doesn’t change over the life of the loan. Though the amount of principal and interest paid can vary month to month, the total payment stays the same. Conventionally, these are offered as 15- or 30-year fixed mortgages, though you can choose anywhere from 10 to 30 years for the duration of a fixed-rate loan. Typically, the longer the life of the loan, the lower your monthly payment. However, with a shorter-term loan, you will pay significantly less interest.
With an adjustable-rate mortgage (ARM), the interest rate is variable. Though variable interest rates may be harder to budget for, with monthly payments frequently changing during the life of the loan, they are often cheaper in the beginning. ARMs have an initial period of a set interest rate before the loan changes based on the market rate. This initial rate is usually set below the market rate. The most common is the 10/1 ARM: the interest rate is fixed for ten years and then is adjusted annually according to an index.
Conforming Vs. Non-Conforming
Conventional loans aren’t guaranteed or insured by the federal government. Examples of government-backed mortgages include loans issued by the US Department of Veterans Affairs (VA loan), the Federal Housing Administration (FHA), and USDA loans backed through the agency’s Rural Development Guaranteed Housing Loan Program.
The most common type of loan is the conventional loan. These are classified as “conforming” or “non-conforming” loans. A conforming loan must conform to financing limits determined by the Federal Housing Finance Agency (FHFA) and meet the funding criteria of a Freddie Mac or Fannie Mae. If you have excellent credit, a conforming loan may be ideal due to lower interest rates.
A non-conforming loan isn’t required to meet these guidelines. Mortgages may become non-conforming due to the borrower’s down payment size, debt-to-income ratio, or poor credit history.
Loan size may also determine if a loan is non-conforming. Jumbo loans exceed the conforming loan limit and are a way to make luxury homes more affordable.
Other Loan Types
Other loans to consider are home equity loans, home equity lines of credit (HELOCs), or combo loans (often referred to as piggyback loans). A home equity loan can be considered a second mortgage, while a HELOC works more like a credit card. You can borrow up to a certain amount during the life of the loan and withdraw and repay as many times as necessary.
A combo loan consists of two separate loans from the same lender. These loans may be preferable for a buyer who can’t come up with a 20% down payment but wants to avoid PMI insurance, has not sold their previous home, or is in the process of constructing a house.
If you have any questions about which loan option is best for you, contact our expert mortgage officers at Rivermark Community Credit Union. Whether you’ve found your dream home, want to tap into your home’s equity, or refinance—we’re happy to provide honest advice and competitive rates.
Now that you know how a home loan works start financing and achieve the dream of homeownership.