A home loan, also known as a mortgage, is a loan used to finance the purchase of a home. Getting a home loan allows you to buy and move into a home now while repaying the loan over time. There are a few key reasons why readers may be interested in getting a home loan:
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Ownership: A home loan allows you to purchase and own your home instead of renting. This gives you an asset that you can build equity in over time as you pay down the loan principal.
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Stability: Owning your own home provides more housing stability compared to renting, as you don’t have to worry about rising rents or getting evicted by a landlord. You can live in your home as long as you want.
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Investment: For most people, a home is their single biggest investment. Home values generally appreciate over time, allowing you to grow your net worth.
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Tax benefits: Interest paid on a home loan and property taxes are tax deductible, which helps lower your taxable income. This can lead to substantial savings each year.
This article provides an overview of key topics related to getting a home loan, including:
- Types of home loans available
- Interest rates and factors that impact them
- Down payment options and requirements
- The role of your credit score and debt-to-income ratio
- Steps in the loan preapproval process
- How to shop for the best loan offers
- Closing costs to expect with your home purchase
- Alternatives to taking out a traditional home loan
By understanding these key factors, you’ll be in a better position to find the optimal home loan for your situation. Whether you’re buying your first home or moving up to a larger one, let’s explore how you can finance a new home through a mortgage loan.
Types of Home Loans
There are several common types of home loans available for purchasing a new home:
Conventional Loans
Conventional loans are mortgages that are not part of any government-backed program. These loans typically require a higher down payment and credit score than government programs, but may have lower interest rates. Conventional loans come with fewer restrictions and can be provided by banks, credit unions, or mortgage lenders.
FHA Loans
FHA loans are government-insured mortgages provided by an FHA-approved lender. They require a lower down payment and credit score than conventional loans. FHA loans have mortgage insurance premiums that can either be paid upfront or added to the monthly payments. These loans are best for those with limited savings or lower credit scores.
VA Loans
The VA loans are mortgages backed by the Department of Veterans Affairs, available only to qualifying military members and veterans. VA loans require no down payment or mortgage insurance. Borrowers still need sufficient income and credit to qualify. These loans can only be obtained from VA-approved lenders.
USDA Loans
USDA loans are mortgages issued in rural and suburban areas by private lenders and insured by the United States Department of Agriculture. Applicants must meet income eligibility rules and buy homes in designated rural zones. USDA loans offer low-interest rates and require no down payment or mortgage insurance. Credit score requirements are also lower than conventional loans.
Interest Rates
Mortgage interest rates are currently hovering around 6%, which is up from historic lows but still relatively affordable from a historical perspective. Rates peaked above 18% in the early 1980s, so we are still in a lower interest rate environment compared to past decades.
Several key factors affect mortgage interest rates:
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The Federal Funds Rate – This is the interest rate set by the Federal Reserve. When the Fed raises or lowers this rate, it impacts all other interest rates, including mortgages. Right now the Fed is raising rates to fight inflation, so mortgage rates are steadily climbing.
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Inflation – Higher inflation typically causes mortgage rates to rise. With inflation at a 40-year high, rates are rising to compensate lenders for the decreasing purchasing power of the dollar.
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Employment – When more people are working, demand for mortgages increases. This increased demand can nudge rates higher.
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Economic Growth – During strong economic times, rates tend to rise as borrowers compete for mortgages. Slow economic growth usually causes rates to fall.
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Bond Market – Mortgage rates generally track the yield on 10-year Treasury bonds. So when bond yields rise or fall, mortgage rates follow suit.
There are a few key strategies borrowers can use to try and get the lowest possible interest rate:
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Improve your credit score – Having a credit score over 740 will qualify you for the best rates. Pay down debts, don’t take on new credit before applying, and correct any errors on your credit report.
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Lower your debt-to-income ratio – Lenders look at your total monthly debt payments (including the new mortgage) vs your gross monthly income. Aim for a ratio below 36%. Paying down existing debts can help lower your DTI.
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Make a larger down payment – Ideally 20% or more. Bigger down payments reduce the risk for lenders so they offer lower rates.
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Shorten the loan term – Opt for a 15-year fixed over a 30-year. The shorter term qualifies you for a lower rate.
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Compare multiple lenders – Rates vary, so shop around with different lenders to try and secure the lowest rate. Local banks and credit unions may offer competitive rates worth exploring.
With some preparation and research, you can potentially find mortgage rates below 6% and secure favorable financing for your new home purchase. Monitoring rate trends and strategically timing your purchase can help land the best possible deal.
Down Payment
When buying a new home, the down payment is the amount of money you pay upfront towards the purchase price. The larger your down payment, the less you’ll need to borrow with a mortgage loan.
Typical Down Payment Required
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Conventional loans typically require a down payment of at least 20% of the purchase price. With a 20% down payment, you can avoid paying private mortgage insurance.
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FHA loans allow down payments as low as 3.5% of the purchase price. However, you’ll have to pay mortgage insurance if your down payment is less than 20%.
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VA loans and USDA loans offer 100% financing options for qualifying borrowers. No down payment is required.
Options for Low Down Payment
If you don’t have enough saved for 20% down, here are some options:
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Lower your purchase price – Consider buying a lower-priced home that requires a smaller down payment. This will allow you to buy sooner.
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Explore low down payment programs – FHA, VA, and USDA loans allow down payments under 20%. State and local programs may also be available.
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Use gift funds – You can use funds gifted from family members for part of your down payment. Lenders allow this with proper documentation.
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Participate in down payment assistance programs – These programs provide grants or low-interest loans to help with your down payment and closing costs. Eligibility requirements apply.
Down Payment Assistance Programs
Here are some popular down payment assistance programs to consider:
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FHA PowerSaver loan – A low interest rate second mortgage that covers up to 3.5% of the purchase price for borrowers who qualify.
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HomeReady Mortgage – Allows 3% down payment and grants up to $6,000 for closing costs for qualifying first-time homebuyers.
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State Housing Finance Agency (HFA) programs – Many states offer down payment and closing cost assistance for first-time buyers.
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Federal Home Loan Bank (FHLB) programs – Local lenders provide discounted rates and down payment grants through FHLB funds.
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Nonprofit programs – Organizations like Habitat for Humanity offer low down payment options with affordable monthly payments.
Alternatives to Loans
Saving up for down payment
One alternative to taking out a traditional mortgage loan is to save up enough money to make a sizable down payment or even pay for the home in cash. This avoids paying interest and having debt, but requires having substantial savings. The downside is it can take many years to save up 20% or more for a down payment. Still, by making homebuying a savings priority, setting up automatic transfers to a separate account, limiting spending, and investing wisely, it’s possible for some buyers to buy with cash.
USDA and VA loans
Certain government programs like USDA and VA loans allow buyers to purchase a home with little or no down payment. USDA loans are for eligible rural and suburban areas. VA loans are for veterans and active military. The advantage is not needing much in savings for a down payment. The downside is these loans can be more restrictive and competitive compared to conventional mortgages.
Owner financing
Some home sellers may be willing to finance the sale themselves, having the buyer pay them directly over time rather than going through a bank. This avoids bank fees and qualifications, but the seller must be willing and able to act as the bank themselves. It also requires a great deal of trust between buyer and seller. Owner financing works best between family or others with an established relationship.