Should You Write a “Love Letter” to a Home Seller?
Dan S | Apr 26, 2022
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By Dan S on Mar 2, 2022
Whether you're a first-time homebuyer or you're starting the homebuying research process again after several years, you might find that there's a lot to know and do when it comes to financing. Before you even get as far as the mountain of paperwork and seemingly endless checklists of items required for the underwriting process, let's start by making sure you understand the different home loan options available to everyday home buyers.
If you don't know where to start researching the best types of mortgages for a house or condo, don't get discouraged. While the sheer number of financing products on the market can be a little intimidating, having a lot of options is generally a good thing — it means you'll likely be able to find a home loan product that suits your needs.
With that in mind, here's a rundown of the different mortgage types you might encounter as you’re doing your research on how to finance your next house purchase.
Adjustable-rate mortgages (ARMs for short), also known as variable-rate mortgages (or tracker mortgages in the UK), are where the lender offers a "teaser rate" for a few years, after which the lender has the option of adjusting the rate based on current market conditions. The most common of these is called the "5/1 ARM," where the rate is fixed for the first five years, and then adjusted annually thereafter. (The first number is the number of years the initial rate is fixed and the second number is how frequently the rate may be changed. So a 7/1 ARM is fixed for seven years, and adjusted every year after that. But be aware: a 5/6 ARM has a fixed rate for 5 years and is adjusted every 6 months for the remaining 25 years! Be sure to read the fine print!)
What's the advantage of an ARM? Adjustable-rate mortgages are often best suited for buyers who are confident they'll be able to sell or refinance the house within the initial fixed period. These buyers want to take advantage of the extremely low interest rate early on and don't intend to still be paying the loan once the rate rises. This can be risky if you're not able to sell the house or refinance (or pay the loan off in full) before the rate increases and you're suddenly stuck with a much higher monthly payment.
Bridge loans (also known as gap financing, interim financing, or swing loans) are short-term loans used to “bridge” a transitional period. In real estate, a bridge loan could be used if someone needs to finance a house before they sell an existing property they own, but are not able to secure long-term financing for the new home yet. Gap financing allows them to bridge the time between buying the new home and selling the old home, as an interim measure, until they are able to secure more favorable long-term financing. Bridge loans are usually secured by the buyer’s current home and are intended for short-term cash flow. They have relatively high interest rates compared to more traditional types of mortgages.
In order to be "conforming," a mortgage loan must meet certain criteria. The Federal Housing Finance Agency (FHFA), as well as Fannie Mae and Freddie Mac, set certain guidelines for home loans that they'll purchase and guarantee. Foremost of these criteria is the loan limit, which is currently $647,000 for single-unit homes in most of the United States (with exceptions for some high-cost areas). Home loans that meet these criteria are called conforming.
All conforming mortgages are conventional, in that they're originated by a private lender and not any government agency. However, not all conventional mortgages qualify as conforming, as they may not meet those federal guidelines.
A mortgage that exceeds the loan limit set in the federal guidelines is called a jumbo loan (see below).
Conventional loans are underwritten by private lenders, not by a government entity; however some conventional loans can still be guaranteed by Fannie Mae or Freddie Mac if they meet the criteria of a conforming loan. Jumbo mortgages are an example of conventional mortgages that do not meet Fannie Mae or Freddie Mac requirements and would therefore not qualify as conforming mortgages. They can have a fixed or variable interest rate. Conventional loans without a 20% down payment are subject to private mortgage insurance (PMI), but PMI can be removed once the home's loan-to-value (LTV) amount reaches a certain threshold.
Loans that are directly backed by the government, such as FHA, VA, and USDA loans instead of private lenders are called non-conventional mortgages and have specific, niche requirements and are, therefore, not available to all homebuyers.
FHA mortgages are an attractive option for buyers who don't qualify for the same loan amount using a conventional mortgage. Because FHA loan requirements aren't as strict, buyers who don't have great credit or have higher existing debt may find this to be a great option for getting into homeownership. These loans are backed and ensured by the Federal Housing Administration of the U.S. government and are available with standard fixed-rate or ARM terms, but FHA loans are generally for smaller amounts than most other typical mortgages. The minimum down payment for an FHA loan is as low as 3.5%.
One commonly noted difference between FHA mortgages versus conventional mortgages is how mortgage insurance is handled. FHA loans with less than 20% down require an upfront Mortgage Insurance Premium (a one-time fee) and an ongoing mortgage insurance premium (MIP) similar to the PMI paid with a conventional loan, but you cannot cancel MIP when you hit a certain LTV. If your down payment was at least 10%, then you'll pay MIP for 11 years; if your down payment was less than that, you will pay MIP for the life of the loan.
Having a fixed-rate mortgage means your interest rate will not change over the course of your loan. Your rate is locked in and your monthly principal-plus-interest payments will stay the same every month, too. This makes it simple to manage your budget and understand the total cost of your mortgage over time. (But do keep in mind that other expenses like property taxes, insurance, maintenance, utilities, and escrow costs may change over the years.)
The two most common periods for a fixed-rate mortgage are 15 years and 30 years – this just means that the loan is spread out over fifteen and thirty years, respectively – though different loan periods are also possible.
A 15-year fixed-rate mortgage is less common than a 30-year fixed-rate mortgage because it requires the borrower to make higher monthly payments in order to pay the loan off quicker. The advantages of a shorter term are lower interest rates and a shorter period over which interest accrues, which leads you to pay a lot less overall while building equity more quickly.
The most popular type of home loan in the United States is the 30-year fixed-rate mortgage – sometimes just called a "30-year fixed" or a "30-year mortgage." The longer term is attractive to first-time home buyers especially because stretching the repayment period over thirty years leads to lower monthly costs, which most borrowers prefer (or need). The disadvantage, compared to a 15-year fixed rate mortgage, is that a 30-year loan typically has slightly higher interest rates and the total sum of the interest over the entire term will be higher. Most people find this to be a good trade-off, especially in a low interest rate environment.
Carryback financing (also called seller carry back, owner will carry, or owner carry back) is where the seller provides financing directly to the buyer, instead of the buyer getting financing through a bank. The seller essentially extends credit to the buyer via a promissory note and the buyer makes payments in installments toward the agreed-upon purchase price.
This can be advantageous to buyers who have difficulty securing a traditional mortgage (due to bad credit, for example). Although there is risk to the seller, there are some potential benefits to them as well. Since the property acts as collateral in the sale, the property reverts back to the seller if the buyer defaults. The seller receives ongoing income from the payments and can defer capital gains taxes on the sale of the property. It also avoids having to negotiate with a bank on the terms of the sale, since the seller will dictate those terms themselves. However, most ordinary sellers would prefer not to deal with the additional hassle of acting as a lender and dealing with the risks of potential foreclosure and would prefer to get all the proceeds of the home sale when they sell, instead.
If your dream home doesn't exist yet and you're looking to build one that meets your exact requirements and specifications, you'll need a construction loan. This type of mortgage is a short-term loan that covers the cost of a house's construction. Once the house is built, you have to apply for a mortgage for the completed home. A construction loan comes in several flavors. A construction-only loan is a one-year, high-risk loan that only covers the construction period. A construction-to-permanent loan converts into a standard mortgage once construction is finished. Finally, an owner-builder loan is for borrowers who intend to be their own contractor and build the home themselves.
A co-op mortgage is for buying into a type of cooperative housing project, which is co-owned by a group of otherwise unrelated inhabitants. While co-ops look similar to condos, their ownership structure is different. Rather than getting a deed to the unit, you purchase shares in the co-op, which grants you a lease of your specific unit. As an owner, you own common areas jointly and are partially responsible for maintenance fees. Co-op purchases require an extensive approval process, including approval by the relevant co-op board, possibly requiring interviews and character references. This type of homeownership model is popular in places like New York City, but is relatively uncommon in other parts of the United States.
Delayed financing is a type of financing where a new homeowner, who has already purchased a home with cash up front, quickly obtains a cash-out refinance (see above) to mortgage the property. This process effectively returns a good portion of the cash used by the buyer to purchase the property. This strategy lets potential buyers buy homes with cash (because sellers prefer receiving cash offers for houses) and then quickly replenish their liquidity. This financing generally requires the borrower to have quite a bit of capital on hand to buy the property in the first place. Learn more about the pros and cons of delayed financing for home purchases.
The HIRO (High Loan-to-Value Refinance Option) program was created in 2018 by Fannie Mae, in the interest of helping homeowners who have Fannie Mae-owned loans to qualify for a refinance loan even if they have little or no home equity. A homeowner might fail to build equity due to falling house prices in their area or some other reason. The object of the HIRO loan is to let homeowners refinance without needing to meet the equity requirements of more traditional refinance loans.
An iLender is a technology-enabled lender that offers a quicker, more streamlined approach to home buying and selling, using the power of cash offers. Working with an iLender is perfect for home buyers who recognize the competitive advantage of making an all-cash offer on a house, but who either can't or wish not to pay for the entire house with their own cash. Using this type of mortgage product, the buyer gets approved by Accept.inc, or another iLender, for the full amount of the sales price and is able to make a cash offer to the seller using their proof of funds. The iLender purchases the home on behalf of the buyer with cash, then sells it back to the buyer under a mortgage. The buyer gets all the advantages of making a cash offer, without having to give up hundreds of thousands or millions of dollars in liquidity all at once.
Interested in learning more about this innovative type of mortgage? Check out our guide on buying a house with cash.
With an interest-only mortgage, the required monthly payments only cover the interest that's accruing on the loan. The total principal balance doesn't decrease as long as the borrower is only making the required minimum payments. Interest-only loans are attractive to borrowers who don't expect to be in the house for long, but these are quite risky. These days, lenders will generally only offer interest-only loans to high-earning borrowers.
A jumbo mortgage is an example of a non-conforming loan — one that exceeds the limits set by the Federal Housing Finance Agency (FHFA) for conforming loans, and so cannot be guaranteed by Fannie Mae or Freddie Mac. These mortgages are for higher loan values and require higher credit scores, high income, and larger amounts of cash on hand. They're generally for buying high-end properties or properties in high cost-of-living areas, and often have stricter requirements than other home loans.
While most mortgages are originated and serviced by private lenders, some are administered directly by one of three government agencies: the Federal Housing Administration, the Department of Veterans Affairs, and the U.S. Department of Agriculture. Because these loans are issued under special circumstances (for example, USDA mortgage loans are typically intended for low-income rural buyers), they tend to have lower requirements and more flexible payment terms. Because they have their own unique criteria, these loans aren't offered to every potential homebuyer (see USDA Mortgage and VA Loan, below).
A non-conforming mortgage is one that doesn’t meet the guidelines of government-sponsored enterprises (GSEs) like Fannie Mae or Freddie Mac, and so cannot be bought or guaranteed by those entities. A non-conforming mortgage might exceed the loan limit (in which case it becomes a jumbo mortgage), or it might not meet other requirements such as down payment size, debt-to-income ratio, credit score, or some other requirement.
While non-conforming mortgages are not "bad" or undesirable, they’re more challenging for lenders because they can't be resold to GSEs like Fannie Mae and Freddie Mac, and so often have a higher interest rate than a conforming mortgage. However, because they don’t have to meet the federal guidelines, non-conforming mortgage loans can be more flexible about things like credit rating, proving income, down payments, and so on, at the cost of higher interest rates.
Some lenders offer a loan product specifically for doctors called a physician loan. New doctors generally have a very high debt-to-income ratio early in their careers, but are expected to make considerably more income very quickly. Physician mortgages allow doctors to take on bigger loans than a typical borrower based on their expected future income and the lender's high expectation that the doctor will easily be able to pay the loan back. In other respects, these loans work like other standard mortgages.
Refinancing is the process of replacing an existing loan with a new one. The borrower takes on a new loan, typically with much more favorable terms, and uses the money to pay off the previous loan in full. There are many good reasons to refinance, including locking in a better interest rate or lowering the monthly payment amount – and often both. Loans can also be refinanced into shorter-term loans in order to pay off the balance sooner (such as refinancing a 30-year home loan into a 15-year home loan).
Cash-in refinancing is the process of refinancing an existing loan but bringing additional cash to the table. This allows the borrower to reduce the principal of their new home loan, which reduces the total debt, as well as reducPing monthly payments even further. One reason a borrower might choose to do a cash-in refi is to get to a loan-to-value percentage that allows them to remove mortgage insurance more quickly.
A cash-out refinance is a loan that lets a homeowner tap into some of the equity they have in their house by getting cash "back" from the transaction; the cost of the cash is rolled into the new loan principal. A cash-out refinance loan is often taken out by borrowers who want to renovate, update, or perform major maintenance on their home, but don't have the savings or income to pay for these costs out of pocket. While it's common to invest the cash-out money back into the home, a borrower can use the extra liquidity for other purposes as well, such as paying off other higher-interest consumer loans.
A reverse mortgage is a loan often taken out by retirees who have paid off their home in full, having likely built up considerable equity in the process. The loan is secured against the paid-for property, allowing the borrower to receive income from their own home equity. This is intended for individuals who might otherwise have difficulties with living expenses. There are fees and closing costs associated with this loan, and this type of loan means losing some of that home equity to interest.
The homeowner, or the heirs of the homeowner, will have to pay the balance once the original borrower no longer lives there — usually by selling the home itself. This option is usually aimed at older homeowners — the Home Equity Conversion Mortgage (HECM), for example, is only offered to individuals 62 and older.
A home renovation or rehabilitation loan is a type of refinancing that bases the amount that can be borrowed on the value of the house after the renovation, rather than before. This means the homeowner is getting credit for the renovation up front, as well as getting a lower rate, due to the loan-to-value ratio specific to renovation loans. There are some drawbacks, however: some construction companies don't like dealing with contracts involving loans like this because of disbursement rates.
Refinancing requires going through a similar process as applying for a new loan – because it is! It can feel like a long and involved process, especially if it involves changing lenders. Streamline refinancing is an option available to qualified homeowners which reduces the paperwork, simplifies the process, and eliminates some requirements (such as a credit check) so a refinancing can happen more quickly.
Streamline refinancing is available for existing FHA loans, as well as USDA and VA loans. You can even work with a different lender than the one holding your current loan as long as that lender offers the same kind of loan. Requirements include being current on your existing mortgage and demonstrating there will be a tangible benefit to refinancing, for example.
The downside? Streamline refinancing is not eligible for any sort of cash payout — it may only be used to reduce an existing mortgage, and cannot be used to tap into equity (as with, say, cash-out refinancing).
A two-step mortgage is generally used by homeowners who are either constructing their own homes, or are planning to flip the property before the loan period is up. A two-step mortgage offers a lower introductory rate at first, then a higher rate after the initial loan period is over. This type of loan product is offered by lenders as a way to attract buyers who might not otherwise be eligible for a traditional loan.
Although two-step mortgages are similar to adjustable-rate mortgages (ARMs), there is an important difference. A two-step mortgage has a single rate adjustment at the end of the initial rate period, at which point the new interest rate is locked in. An ARM may adjust the interest rate several times over the life of the loan — such as the 7/1 ARM, which adjusts the initial rate after seven years, then each year thereafter.
USDA loans are offered through the United States Department of Agriculture, through programs like the Single Family Housing Guaranteed Loan Program. These government-backed home loans are generally offered to buyers in more rural areas, who can't necessarily make a large down payment. They have fewer restrictions and lower interest rates than other mortgages, but require an annual fee and other up-front guarantees. They're also only available in certain areas.
A VA mortgage is offered exclusively to qualified members and former members of the U.S. armed services. Because they are, in essence, a reward for faithful service to the United States, they may offer substantially more favorable terms to veterans, including no down payments or requiring lower credit scores. These loans are backed by the Department of Veterans Affairs and do generally require a VA funding fee.
Other types of mortgage loans available to veterans include the VA Refinance Rate Reduction Refinance Loan (VA IRRRL), also known as a VA Streamline Refinance loan, This type of loan is a streamline refinance loan (see above) available exclusively to veterans, which allows them to switch from an adjustable to fixed rate, or to refinance to get a lower interest rate.
We hope this introduction to some of the many types of home loans that exist is helpful to you as you research your mortgage options. Keep in mind that not every lender offers every type of loan, and not every type of loan listed above is an appropriate choice for every home buyer. An experienced loan officer will be able to explain your options and guide you to the best mortgage for your needs.
For the best mortgage lender in Denver and surrounding cities in Colorado, plus Arizona, and the greater Portland area, ask your real estate agent who they recommend for making all-cash offers, or contact Accept.inc to get Cash Approved today!
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