When most people think about getting a home loan they think of going to their local bank and getting a traditional 30 year fixed mortgage. However, there are many more options that in some cases may make more sense based upon your intentions with the property. Different types of mortgages can include zero down loans, interest only loans, and adjustable rate mortgages, just to name a few.
Length of Term
Most loans are for a period of 30 years, however, there are some loans terms that span 15 or 20 years, but they are less common. A 15 year of 20 year mortgage usually has a lower interest rate, but a higher payment given that the payoff will be made over a much shorter time period. A mortgage payment typically includes principal, interest, real estate taxes, and hazard and mortgage insurance -- commonly referred to by the acronym P.I.T.I. During the first few years of a mortgage the majority of the monthly payment goes to interest. It is usually around half way through a 30 year term before the amount of principal being paid begins to exceed the amount of interest paid.
Zero Down Home Loan Options
Down payment requirements can vary based upon the type of mortgage you obtain. There are zero down loans available from government organizations such as USDA and VA. USDA programs are in place to help stimulate rural development so these loans are primarily available in areas that are more rural. There are maps available online to help in locating areas that fall within USDA boundaries. VA loans are geared to assist military personal in becoming homeowners. Zero down home loans may also be available from other private institutions such as credit unions. Many credit unions offer first time homebuyer options that require little or no money down.
Unless you put down 20% or more when you purchase your home, you will likely have to pay mortgage insurance. This is an insurance designed to protect the lender in case the borrower defaults. Mortgage insurance eventually drops off after a set number of years, or if property values increase substantially you can request an appraisal (at your expense). If the appraised value shows a 20% equity position or greater, your lender will drop the mortgage insurance.
There are a few low down payment loans available that do not require mortgage insurance, such as HomePath mortgages which only require a 5% downpayment. HomePath mortgages are made available by Fannie Mae on select foreclosures.
FHA is another government organization that is aimed at helping first time homebuyers. FHA is not the actual lender, as is commonly believed, but is a government sponsored insurance given to approved lending institutions to insure them against the default of the borrowers. Typically a down payment of 3.5% is required and mortgage insurance is paid up front when you close on the loan.
Adjustable Rate Mortgages and Interest Only Loans
There are alternative loan options such as adjustable rate mortgages (ARM’s) and interest only loans. These types of loans offer lower monthly payments but there are potential drawbacks to be aware of. With ARMs there is a low introductory interest rate that usually increases after a certain period of time, typically after 1 year, 3 years, or 5 years. After the introductory period the rate will rise annually or bi-annually based on a set index or schedule. This means that your monthly payment will eventually increase. In some cases this can put a homeowner in a difficult financial position, and they may need to refinance or sell if they have enough equity to do so.
With interest only loans the interest rate is typically set, however, the amount of the principal remains the same and is never paid down. In times of real estate appreciation this may not present a problem, but if real estate depreciates the lack of principal pay down means that no equity is being built and the home may become ‘underwater.’ In areas where the cost of living and real estate costs are extremely high, ARMs and interest only loans can allow people to become homeowners that may not have been able to with traditional 30 year fixed mortgages. If you intend to only stay in your home for 5 years or less, an ARM may make sense for you, but make sure you plan for that 5 year mark in the event you don’t end up moving.