Types of Loans when Buying a House

2010-07-13

Home Buying, Selling & Renting, finances

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The types of loans when buying a house available in the mortgage market can be intimidating to any person and especially so for a first-time home buyer. There are fixed rate mortgages, adjustable rate mortgages, interest only loans, veteran assistant programs and so many more. Choosing the right kind of loan is especially important when buying a house since a home is often the most important investment a person makes and home mortgages typically have a span of thirty or fifteen years. A borrower who takes a $200,000 home mortgage at an interest rate of 6.5% ends up paying $267,838.98 with interest over a period of thirty years.

Types of Loans for Buying a House

Home mortgages come in different sizes and shapes but the two most important ones are adjustable rate mortgages and fixed rate mortgages. In a Fixed Rate Mortgage or FRM, the interest rate does not change throughout the term of the loan. This makes it easy to calculate the monthly payments and the home buyer can plan his monthly budget accordingly, since his mortgage payments are not going to vary month by month. This stability comes with a price though, Fixed Rate Mortgages have higher interest rates than Adjustable Rate Mortgages.

Types of Loans for Buying a House

Adjustable Rate Mortgages have flexible interest rates and the rates can go up or down in the future. So basically the home buyer is taking a risk when he opts for an ARM. He is rewarded for that risk by a lower interest rate than that for an FRM. ARMs are suitable for home buyers who do not plan to stay in their home for more than five to seven years. Most Adjustable Rate Mortgages have a teaser period in which the interest rates are substantially lower than that of FRMs. A considerable amount can be saved in interest if the housing loan is closed before the teaser period is over.

There is no home mortgage that fits all. The type of loans that are available in the market for buying a house differ according to the the needs and requirements of the home buyers. An interest-only mortgage lets the borrower pay only the interest for an initial period. The main advantage of an interest-only loan is the lower monthly payment but since it does not contribute anything to the principal, the loan amount remains the same. A balloon loan acts like an FRM during an initial period, but after that the borrower need to repay the amount in full. He can repay the loan amount, renew the loan as an interest only loan or change it to an FRM. A biweekly mortgage allows a borrower to make payments every two weeks instead of every month. Since there are 52 weeks in an year, a borrower who has taken a biweekly mortgage makes 26 payments a year instead of 12(in the traditional loan) and so this adds up to an additional thirteenth payment. This ‘prepayment’ of mortgage allows him to pay off the mortgage earlier than a regular borrower.

A biweekly mortgage allows a borrower to make payments every two weeks instead of every month. Since there are 52 weeks in an year, a borrower who has taken a biweekly mortgage makes 26 payments a year instead of 12(in the traditional loan) and so this adds up to an additional thirteenth payment. This ‘prepayment’ of mortgage allows him to pay off the mortgage earlier than a regular borrower.

FHA and VA Loans for Buying a House

Most conventional loans require the borrower to come up with a sizable down payment. FHA loans are for those borrowers who do not have the 20 percent down payment that is needed for conventional loans, FHA loans need only 3.5 percent as down payment. These type of loans are insured by HUD and so they are less risky to the lenders and the borrower gets interest rates on par with conventional loans.

Veteran Assistant loans are for veterans and active service personnel in the U.S Army. The loan is guaranteed by the U.S Department of Veterans Affairs and so the lenders are protected in case of a default. This translates itself into lower interest rates and better terms for the veterans. A person who is qualified for a VA loan is better off choosing a VA loan than a conventional or FHA loan.

It is necessary to analyze all the different types of loans available in the mortgage market when buying a house and choose the one that is the perfect fit. A borrower may be better off with an ARM if the interest rates in the market are at an all-time high, even if he prefers the stability of an FRM. The right type of loan can save thousands of dollars in interest.

Resources

1. U.S Dept of Housing and Urban Development Website, www.hud.gov/buying/loans.cfm.

2. U.S Department of Veteran Affairs Website, www.homeloans.va.gov/elig2.htm.

3. The Federal Reserve Board Website, https://www.federalreserve.gov/pubs/arms/arms_english.htm.

Photo by Penny Mayes [CC-BY-SA-2.0 (https://creativecommons.org/licenses/by-sa/2.0)], via Wikimedia Commons