Pfanntastic Home Buyers Handbook Chapter 6 a.- Financing Options
In our journey towards buying your 1st home, so far we have covered.
- A broad overview in buying your 1st. Home
- Location, is Everything
- Selecting a Realtor
- Preparing to View Homes
- Watching the Market
Please review the previous chapters for more details, and or contact Peter of Linda Pfann.
Financing your first or any new home purchase home can be the most frustrating part of the home buying process. This is the time when
you will figure out how to pay for the home. Most people have to take out a mortgage loan in order to afford the price. Which mortgage loans are right for you? How much of a down payment will be necessary? What is Additional Fees / Costs?
You will likely have many questions about financing your first home. By knowing the facts, paying attention to interest rates, and looking into all of your mortgage options, you will be able to choose repayment terms that will fit your current income and allow you to safely make those monthly (or biweekly) payments.
Types Of Home Loans
Deciding which home loan is the right one for you will depend on what you qualify for and what your lender is willing to give you. There are a few types of mortgage loans, including:
- Fixed rate mortgage loans
- Variable Rate mortgage loans
- Open Mortgages
- Seller or Private Financing
- Interest Only Mortgages
You should be familiar with these loans so that you will be able to make an informed decision when it comes to financing your new home.
Fixed Rate Mortgage Loans (closed)
This is the most commonly used mortgage form for 1 st. time home buyers. For first time home buyers who are on a strict budget, choosing a fixed rate mortgage may be the loan for you. Your monthly payment will never change for the term of the loan because you will lock into the interest rate given at the time the loan was processed. You can take out fixed rate mortgage loans that range from one all the way up to thirty years.
The key advantages to taking out mortgage loans that have fixed rates are:
- You will be able to create a monthly budget for yourself.
- You will never be surprised by the amount you will have to pay each month.
- You will typically be able to lock into a low interest rate.
The disadvantages may not mean much to you now, but could include :
- If your family or your income grows, you may want to refinance and pay less each month so that you will be able to afford renovations, vacations, and other luxuries.
- Since your mortgage is fixed, if interest rates drop, you will be trapped paying a higher rate.
- While you can refinance your mortgage, you may have to wait a certain amount of time, and even then there will likely be pre-payment penalties
For those who have limited income, who have lower credit scores, or those who want the security of paying the same amount each month, then a fixed rate mortgage is the loan for you.
Variable Rate Mortgage Loans
If you expect interest rates to go lower and or remain low, you might think about moving in the next few years, and or want to buy a bigger home, you may be interested in an variable rate mortgage. The major difference between a variable rate mortgage and a fixed rate mortgage is that the interest rate may vary from time to time and is related to the banks prime lending rate. Most Variable mortgages will allow you to convert the mortgage in to a Fixed Rate mortgage at your request (obviously terms and conditions will apply).
Variable Rate Mortgages are not for those that need or prefer stability and predictable expenses. The method by which the interest rate is determined comes from the prime lending rate plus a predetermined added rate (so if the prime rate goes up, so does the cost of your monthly mortgage payment, conversely if the prime rate comes down, so does your mortgage cost)
Variable Rate Mortgages, are best for times, when interest rates are expected to come down, or are expected to remain stable. Variable Rate Mortgages, are a little higher risk but have the benefit of typically lower rates compared to fixed term mortgages (at the time you apply for them).
Open Mortgages
Open Mortgages, are in many way similar to fixed rate mortgages, in so far that they have a fixed interest rate, but the advantage of these types of mortgages is that they can be paid off at any time without penalty. The one downside is that typically the interest rates charged for an open mortgage will likely be slightly higher than a fixed rate closed mortgage.
Seller and or Private Financing
Not as common as it used to be, but seller financing and or private financing still occurs from time to time (even to 1 st. time buyers). Because (as the name says) this type of financing is private and personal, all terms and conditions are negotiated between the buyer, and the lender or seller, but often will use either the form of a fixed or variable rate mortgage.
The advantage for buyers can be that otherwise harder to finance buyers, may find a more flexible set of rules from private lenders and or property sellers.
The main disadvantage may be that one rarely knows if private and or seller financing is available for any one property, and as such it is hard to rely upon in advance of starting your home buying journey.
Interest Only Mortgages
Payments in type of mortgage are, as the names says, only covering the Interest portion of the mortgage and does not reduce the principal (loan amount) of the mortgage. For most 1st time home buyers this type of mortgage would not appear to make a lot of sense, to have a mortgage that you actually never pay off, seems a bit silly, but in some cases and in a rapidl
y appreciating market place it can be an option to consider.
Just imagine that you buy a property today at say $ 200,000 with a minimum downpayment of 5% for $ 10,000 and a mortgage of $ 190,000 (for the sake of the example we are ignoring mortgage insurance fees etc.) with interest only payments at 5% your interest only payment would be approx. $ 833.34 (very affordable). So now let's assume for a moment that the value of your property appreciates at an average rate of 7% over 10 years (not unusual for a typical market place) the value of your property would nearly double @ approx. $ 393,000. So although you never paid off a penny of the mortgage, you still now have over 50 % equity and could use this strategy to enter the market with lower than average payments and a healthy equity position in a few years.
In times (like right now) where the market conditions are not as typical and stable, this is not an advisable strategy, and many of the lenders would likely not make this option avialable.
It is always good to know your options and we would encourage you to contact Peter or Linda Pfann, for any questions you may have about the various methods and choices available to you to finance your 1st home.
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