The first step in getting a loan is to find out what is available in the market. It is a good idea to check several sources before committing since the variation in interest rates, discount points and types of loans offered can be great.
Mutual savings banks and Savings and loan associations. Thrifts are institutions that specialize in home mortgage loans. Like commercial banks, they take in and pay interest on deposits from individual savers; then they lend these funds out to borrowers. Thrifts should be one of the first places you check for a loan.
Commercial banks. They do most of their lending on a short-term basis, such as auto loans and business loans. At times, however, they also make long-term mortgage loans.
Mortgage companies. These are prime sources for mortgage loans. Unlike savings and loans, mortgage companies do not collect deposits from savers. They obtain their funds by selling the loans they originate to investors, other lenders and the major secondary market agencies. Also, it makes little difference to the borrower whether the loan is retained by the lender or sold in the market. In most cases, the originator will continue to collect payments and manage the escrow account.
Credit Unions. Credit Unions have been known to make home mortgage loans. This source could be worth checking if you are a member of a credit union.
Home finance companies. They rarely make first mortgage loans for purchasing a home, but may be a source for second mortgages to help finance the down payment on a home.
Individuals. People also make home loans. Most often, these people are sellers who are willing to help finance the sale. When interest rates are high, or loans from established lenders hard to find, sellers may offer to take back a note as a way to clinch the sale. Seller financing differs in several ways from a loan from a third-party lender. The financing is tied to a particular home offered at a particular price (which may be higher than the price you would pay without the financing). The loan is usually short term with a balloon payment. That means you must refinance the loan after a few years. These loans are meant for special situations but can be worthwhile when those situations occur.
Government agencies. The government sometimes makes loans. In general, these loans are highly restricted to certain income groups or other target groups. Some state and local governments have money available from the sale of bonds to make home loans to first-time buyers. The loans are originated by established lenders, so inquire about these when you check out rates.
Federal Housing Administration (FHA) and Veterans Administration (VA) loans are made by private lenders using their own funds. The government backs up these loans if the borrower fails to make payments and the home is foreclosed. For FHA loans, the government provides insurance against default. The borrower pays a premium for this insurance. Similar insurance is provided by private companies for conventional loans. VA loans are guaranteed by the government and are available as a benefit to qualified military veterans. If you qualify, bring your DD214 form to the lender. The main advantage of these types of loans is the lower down payment required. In addition, FHA and VA loans may be assumed without an increase in the interest rate.
Loan Types
In many cases, getting the right loan can determine whether or not you can afford to buy the house you desire. Some loans require large cash down payments, while others call for relatively modest investments. Some have larger monthly payments than others. With some loans, the monthly payments vary over time. You will want to find the least expensive financing that fits your financial situation with adequate security.
Over the last several years, a great number of financial variations have developed for home buyers. At one time, the fixed-rate, fixed-payment loan was used exclusively by home buyers. Now there are loans whose payments vary as interest rates change, and those who payments start out low and rise over the years. Loans with relatively short terms (such as 15 years instead of 30) are growing in popularity. This expanded list of options makes the loan selection decision a complicated one.
Fixed rate mortgage. The standard loan covers 80 percent of the cost of the home, or the appraised value, whichever is lower. (Some lenders may offer loans in excess of 80 percent, but these higher loan-to-value ratio loans usually carry higher interest rates and costs.) The remainder of the cost is the cash down payment that you must provide at closing. Lenders also charge discount points as a condition of making the loan. Each point charged requires the buyer to pay an amount equal to one percent of the loan amount in cash at closing. An estimate of all these expenses will be given to you when you apply for the loan.
Each monthly payment on the fixed-rate loan includes interest on the outstanding principal plus repayment of a part of the principal borrowed. In this way, the loan will be completely paid off at the end of the mortgage term. If you pay the loan back before the end of the term, the amount of principal you owe will be less than the amount you borrowed. The gradual reduction in principal is called amortization. Each payment of principal and interest is equal over the life o the loan. Since you are gradually paying back the principal with each payment, the amount of payment devoted to interest decreases over time. This means the amount of principal paid back increases with each payment. Therefore, the older the loan the faster you are paying the loan off. Each monthly payment may include a payment to an escrow account used for paying hazard insurance premiums and property taxes. While the interest and principal remain unchanged, the total payment may change over time because of increases or decreases in the escrow payment required.
It is possible to get mortgage loans for more than 80 percent of the cost if the loan is insured. (This should not be confused with mortgage life insurance, which pays off the loan in the event of death or disability of the borrower.) The FHA insures home loans for up to 97.5 percent of value. Limits on the dollar amount of the loan make FHA insurance appropriate for low to moderately priced houses. Loans not insured by the FHA (or guaranteed by the VA) are called conventional loans. These loans can be insured by Private Mortgage Insurance (PMI) companies. PMI loans are not as restrictive in amount as FHA loans. Insurance, either PMI or FHA, requires additional premium payments at closing and may require an annual fee of one-quarter to one-half of one percent of the principal.
Adjustable rate mortgages. Since 1980, adjustable rate mortgages (ARMs) have become an important part of the mortgage market. One reason is that lenders like the protection that ARMs give them from the effects of rising interest rates. Another reason is that ARMs usually start out with lower interest rates than comparable fixed-rate mortgages. Some home buyers find they can afford to borrow more with an ARM than they could with a higher interest rate fixed-rate mortgage. The main difference between ARMs and fixed-rate loans is that the interest rate on the ARM may vary periodically. At pre-established intervals ranging from three months to five years, the lender may change the interest rate. This is done by monitoring an index of interest rates and maintaining a set relationship between the interest rate and the index. The index may be the market yield on some government security, the average mortgage interest rate in the nation, or the cost of the money used by lenders to make loans. When the interest rate on the loans is changed, the monthly payment will change accordingly. This means the amount you pay on your loan for principal and interest may vary significantly over time. One way borrowers are protected from large changes in payments is through pre-set limits, or caps, placed on the interest rate adjustment. Some loans have caps that apply to the periodic adjustment and a cap on the overall change in the interest rate over the life of the loan. Some loans also have limits on the amount of change in the payment, but not on the interest rate. This type of cap can create negative amortization, a situation in which the amount of principal owned may increase over time.
Graduated payment mortgages. The FHA also insures loans in which the interest rate is fixed, but the payment rises according to a pre-set schedule. These are called Graduated Payment Mortgages (GPM) because the payments are increased each year during the early life of the loan. The effect is to reduce the payment level in the first few years and to increase it somewhat in the middle and later years. The GPM is intended for young home buyers whose relatively low income is expected to grow over the years. The predetermined amount of change in the payment is not dependent on the movements of an index, although there are loans which combine the features of the GPM and the ARM. The common type of GPM involves negative amortization for the first several years.
Interest saving loans. Some home buyers become dismayed when they learn the amount of money they must spend in interest over the life of a long-term mortgage loan. The total costs may be several times the price of the home. This concern has drawn attention to loans designed to cut down on the interest expense. In all cases, these types of loans require larger or more frequent payments.
One type of interest-saving loan is a fixed-rate loan with a 15-year term. Total interest expense can be reduced significantly, although the monthly payments are somewhat higher. For example, a loan of $50,000 at 10 percent interest requires a principal and interest payment of $438.79 when paid over 30 years. The total interest paid is $107,963. If the same loan is paid over 15 years, the monthly payment increases to $537.30 or about $100 more per month. Total interest paid, however, is only $46,714, a savings of over $60,000.
Other types of loans have been developed to save interest by paying off the loan faster. One type is the Growing Equity Mortgage (GEM) which has a payment that increases periodically. Unlike the ARM or GPM, the increase in the payment is devoted to reducing the loan principal, so that the loan is retired in about half the original term. Another type, the bi-weekly, requires payments at two-week intervals (coinciding with payday for many workers) of half the normal monthly payment. Since there are 26 two-week intervals in the year, the borrower pays the equivalent of 13 months of payments, and the principal is paid down much faster.
Loan assumptions. In some cases, it may not be necessary to obtain a new loan. Some sellers have existing mortgage loans that can be assumed by the buyer. When interest rates have risen, existing loans may have interest rates, and payments, much lower than those required for new loans. The buyer may be able to avoid many of the closing costs associated with new loans as well. Assumable conventional loans are becoming rare because in recent years lenders have included "due on sale clauses" in the loans. These provisions entitle the lender to call the loan due or raise the interest rate if the house is sold. Loans insured by the FHA or guaranteed by the VA are generally assumable at the original interest rate.
There are several drawbacks with assumable loans. The seller may want a higher price because o the loan, and the loan may cover a relatively small proportion of the cost of the home. In some cases, the latter problem has been overcome by the seller taking a second mortgage as part of the purchase price.
Source: Barron's Real Estate Handbook, Third Edition