When it comes time to buy a home, many homeowners are initially somewhat overwhelmed by the sheer volume of purchasing options available to them. With a variety of unique mortgage platforms in existence today, as well as seller financing opportunities, buyers can explore at length a myriad of different methods for financing their purchase. Whatever your preferred option to buy a house may be, it's worth taking the time to explore other opportunities you may not be aware of or wish to learn more about.
TL;DR (Too Long; Didn't Read)
Buying a home can be a complex process, due in large part to the various financing opportunities available today. Depending upon your credit score and financial history, you may discover that your interests are best served by a private loan, an FHA loan or seller financing.
Exploring Mortgage Basics
When people think about buying a home, they usually begin planning to apply for a mortgage. A home mortgage has long been considered one of the most popular and trusted forms of financing to help bridge the gap between an individual's finances and the sale price of the property they wish to buy.
Generally speaking, mortgages can be divided into two categories based upon the specific entity or entities financing them, those being conventional private mortgages and Federal Housing Administration loans. Understanding the differences between these two platforms is critical.
Understanding Conventional Private Mortgages
If you are ready to begin applying for financing, your first impulse will most likely be to research various banks or credit unions that offer mortgage loans. When a private entity such as a bank offers mortgage financing, these loans are classified as conventional private mortgages. Qualified buyers can expect to receive the best possible financing terms from private lenders. However, these lenders are free to establish stringent qualifications to ensure that only the most qualified, low-risk applicants are eligible.
When a bank evaluates a candidate for a mortgage, they are essentially creating a risk profile based on the applicant's credit score, debt burden, payment history and a variety of other factors. Depending upon the profile generated, an applicant may be offered a broad spectrum of financing options, or no financing opportunities at all. If, for example, an applicant's credit score is below the minimum threshold required to secure financing, they will almost always be rejected.
Mitigating Risk in Conventional Mortgages
When discussing risk relative to mortgages, it is commonly acknowledged that the primary risk associated with this form of lending is a borrower default and subsequent foreclosure on the property. If, for example, a borrower walks away from a home mortgage with $300,000 left in their mortgage, the home will be repossessed by the lender and eventually resold. This process is by no means cost effective for the lender, which is why they try to avoid offering financing to individuals who they feel pose a significant risk of default.
Interest rates are considered the most popular and fundamental hedge against default risk today. Lenders can attach an interest rate to mortgage lending that directly reflects the degree of risk they perceive in the applicant. If, for example, an applicant has a mediocre credit score and is unable to put a large deposit down, the lender may choose to still offer financing, albeit with an elevated interest rate attached to it.
Generally speaking, private mortgage lenders expect homebuyers to be able to pay 20 percent of the sale price of the property as a down payment. Failure to do so doesn't disqualify someone from securing financing, but it does mean that they will most likely be required to pay for private mortgage insurance, or PMI, on top of their regular mortgage payment.
Fixed Vs Variable Rate Interest
Interest can accrue on a mortgage as part of a constantly adjustable schedule of rates or as a fixed rate attached to the balance over the lifetime of the loan. These two methods are referred to as variable interest rates and fixed interest rates, respectively.
Both of these options offer unique advantages and disadvantages for applicants. A fixed interest rate provides a degree of security and peace of mind for applicants, as it legally cannot change during the repayment schedule of the loan. This rigidity may not be appealing to some homebuyers who may feel that their finances have taken a hit during the closing on the house.
Variable interest rates typically start out at attractively low levels and rise over the course of repayment. According to federal regulations, a lender is required to provide a potential borrower with the full schedule of interest rate adjustments throughout the lifespan of the mortgage prior to any contract being signed. Whereas the rates may initially seem very advantageous, buyers should look carefully to ensure that they won't be forced to pay outrageous amounts of interest in the final years of repayment. By any standard, a variable interest rate plan requires more research and planning than a fixed interest rate policy.
FHA Loan Basics
When exploring different ways to purchase a home, it is also important to remember that the federal government offers assistance to first-time buyers and buyers with mediocre financial history as part of the FHA home loan program.
Although the federal government does not explicitly offer financing to applicants, they work alongside select private lenders to back loans made to applicants. Because of the federal support attached to them, applicants can secure this financing as part of significantly relaxed eligibility requirements. For starters, applicants are only required to pay 3.5 parent of the home price as a down payment. Applicants whose credit score is within the upper 500's can still qualify for these loans.
In exchange for these conveniences, applicants who secure FHA financing will be required to pay an upfront mortgage insurance premium, as well as monthly mortgage insurance premiums in addition to their standard mortgage payment. This scenario still works out to be financially advantageous for those who would otherwise be unable to buy a home.
Seller Financed Properties
In some scenarios, individuals can buy a home without relying on a traditional mortgage at all. Seller financing is yet another popular route to homeownership in which the seller of the home negotiates a payment plan directly with the buyer that does not require the involvement of a bank lender. This option is generally considered an advantageous route for those whose poor credit history would render them ineligible for the majority of other established financing options.
Seller financing interest rates will typically not be competitive with banks. However, given the fact that some applicants simply cannot qualify for bank financing, seller financing programs may be the only option to buy a house.
Ryan Cockerham is a nationally recognized author specializing in all things innovation, business and creativity. His work has served the business, nonprofit and political community.