What You Need to Know About Mortgages

 

If you are a first-time homebuyer, or it has been several years since your last home purchase, the mortgage process may feel a bit daunting. It is important to remember, however, that with knowledge comes power. The more you know about mortgages and the available types, the more likely you will find the perfect fit for your financial situation.

Mortgages are loans that are secured by the property that the loan is used to purchase. The mortgage lender has a lien on the property, which means that if the borrower fails to make payments on the loan, the lender can take possession of the property. Several different types of mortgages are available, each with its benefits and drawbacks.

A conventional loan is not backed by any government entity, such as the Federal Housing Administration (FHA) or the Department of Veterans Affairs (VA). Because there is no government backing, these loans tend to have stricter eligibility requirements, including a higher credit score and a lower debt-to-income ratio. Conversely, conventional mortgages may have lower interest rates and down payment requirements than government-backed loans.

Government-backed loans, on the other hand, are guaranteed by the government in case of default. The most common government-backed loans are VA and FHA loans. VA loans are only available to active duty military and veterans, while FHA loans are available to all borrowers. These loans tend to have more relaxed eligibility requirements, making them a good option for first-time homebuyers or borrowers with less-than-perfect credit.

A fixed-rate mortgage has an interest rate that remains the same for the duration of the term. This stability makes fixed-rate mortgages a good option for borrowers looking to stay in their homes for several years.

An adjustable-rate mortgage, commonly shortened to ARM, is so named because the interest rate can be adjusted over the loan term. These loans typically start with a lower interest rate than fixed-rate ones, but the rate can increase or decrease depending on market conditions. ARMs are a good option for borrowers who plan to sell their homes within a few years or expect their income to increase over time.

The term of a mortgage is the length of time you have to pay off the loan. The most common mortgage terms are 30 years and 15 years. A 30-year mortgage will have lower monthly payments than a 15-year mortgage, but it will take longer to pay off the loan.

 

Aside from the monthly payment you can expect when paying back a mortgage loan, other costs are associated with taking out a loan.

A down payment is the upfront fee you pay when taking out the loan. For conventional mortgages, the down payment is typically 20% of the home’s purchase price.  For government-backed loans, the down payment can be as low as 3.5%.

Closing costs are the fees associated with processing and closing the loan. These fees can include appraisal fees, origination fees, and title insurance. Appraisal fees cover the cost of having the property appraised, while origination fees cover processing the loan. Title insurance protects the borrower and lender from any legal issues from purchasing the home.

Private mortgage insurance (PMI) is required for conventional mortgages with a down payment of less than 20%. PMI protects the lender in case of default and is typically paid monthly along with your mortgage payment.

Mortgage points are fees you can pay at closing to lower your interest rate. One point equals 1% of the loan amount and can reduce your interest rate by 0.25%.

Choosing the right mortgage is a big decision, and there are a lot of factors to consider. Working with a loan officer or mortgage broker can help you compare different loans and find the one that best fits your needs.

As a luxury buyer, you may be tempted to pay cash for a property rather than fuss with the hassle of getting a mortgage. However, there are several reasons why you might want to consider taking out a loan instead.

Firstly, if your income is stable and predictable, you keep your cash reserves intact in case of an emergency, or for other purposes, like paying for college or investing. For many buyers, it can be financially prohibitive to tie up several million dollars in cash purchase of real estate.

Secondly, you can deduct the interest you pay on your mortgage from your taxes. This deduction is especially valuable if you itemize your deductions and are in a high tax bracket.

Thirdly, mortgages are considered a form of “good debt” by many financial advisors. You can improve your credit score by making mortgage payments regularly and on time.

 

If you decide to take out a loan on your luxury real estate purchase, you won’t be taking out a conventional mortgage but something known as a “jumbo loan” when buying in the luxury market.

Jumbo loans are mortgages that exceed the conforming loan limit set by Fannie Mae and Freddie Mac. A conforming loan protects the lender if the borrower defaults, but luxury purchases far exceed the current conforming loan limits. In 2022, the baseline is $647,200 in most of the United States and $970,800 in markets where the median cost is high. Mortgages above these limits that would otherwise meet the requirements for a conventional mortgage are known as non-conforming conventional loans, colloquially termed jumbo loans.

Since jumbo loans do not conform to government agency limits, you must meet the specific lender’s requirements. These requirements usually look like this:

 

 

If these terms don’t work for you, you could put down half the purchase price as the down payment, which may let your loan fall within conforming limits. Alternatively, you can use a multi-loan structure known as piggybacking, which is usually split as 80 percent of the total cost of the new property on one mortgage, 10% on a second loan, and a 10% down payment.

Before making any final decisions on loan types, speak with a financial advisor, like a mortgage broker, to discuss your unique situation. For help finding the right luxury property or a mortgage broker recommendation, reach out to experienced local agent Johnathon De Young.