At American Dream Realty in Woodland Hills, we understand how intimidating and complicated the home buying process can be. If you’re planning to purchase a home in California, there’s a good chance you’ll need to apply for a home loan or mortgage. In part one of this series, we discussed the basics of a mortgage and how to apply for one. In part two, we’ll look at how home mortgages are structured as well as the different types available.
How Are Mortgages Structured?
When you are approved for a mortgage, you’ll pay the principal, interest, taxes, and insurance, all of which are referred to as PITI. It’s important to note that unless you are a high-risk borrower, you may have the option to choose to pay your taxes and insurance separately from your mortgage to give you a lower monthly payment. Let’s look at how each component of PITI works below.
The principle is the original amount of money that you borrowed to pay your mortgage. The bank or institution that you borrowed from decides how much they will lend you based on a variety of factors including income, credit, and down payment. If your down payment is less than 20 percent of the home’s price, your bank may consider you to be a risky lender which can result in a higher interest rate.
The interest is essentially the cost of borrowing the money for your new home. When you take out a mortgage, you agree to an initial interest rate which determines how much you pay a lender to keep lending. This number is often expressed as a percentage, such as five to six percent.
When you purchase a home, you are deemed reliable to pay the property taxes. These taxes go towards supporting the city, school district, and county, and you can pay them along with your mortgage each month. This number is often expressed as a percentage of your property value, so you may be able to estimate what you might pay by searching public records for property taxes nearby.
Your homeowner’s insurance is reserved to protect against fire, theft, and other disasters, and is normally held in an escrow account. If you’re a high-risk borrower, or if you can’t afford the 20 percent down payment, you may be required to have private mortgage insurance. This helps the lender guarantee that they will get their money back if you cannot pay it for some reason.
Different Types of Mortgages
There are many different types of mortgages available to homebuyers in California. For the sake of simplicity, we’ve boiled it all down to the following options:
Fixed vs. Adjustable Rate
When you start shopping for your home mortgage, there will be many different options available to you. One of the first choices you’ll need to make is whether you want a fixed-rate or an adjustable-rate mortgage loan. While most loans fit into one of these two categories, you may also come across a hybrid category in your search. Let’s look at the difference between these two rates below.
- A fixed rate mortgage loan will have the same interest rate for the entirety of your repayment term. This means that your monthly payment will stay the same, month after month, and year after year. This is even true for long-term financing options like a 30-year fixed-rate loan.
- Adjustable rate mortgage loans, or ARMs, have an interest rate that will change or adjust from time to time. Most ARMs will change every year after an initial fixed period, which is also known as a hybrid option.
As you can imagine, each of these loans has its own pros and cons. While the ARM loan starts off with a lower rate than the fixed-rate loan, it has the uncertainty of adjustments down the line. With an adjustable mortgage, the rate and monthly payment can change and rise over time. One of the biggest benefits of a fixed loan is that the rate and monthly payments always remain the same.
Government Insured vs. Conventional Loans
Once you’ve decided on a fixed-rate or adjustable-rate loan, it’s time to decide whether you want to use a government home loan (like a FHA or VA) or a conventional loan. A conventional home loan is not insured or guaranteed by the federal government in any way. Government-insured home loans may include:
The Federal Housing Administration (FHA) mortgage insurance program is managed by the Department of Housing and Urban Development (HUD), which is a department of the federal government. FHA loans are available to all kinds of homebuyers. A major advantage of this program is that it allows you to make a down payment as low as 3.5 percent of the original purchase price. A disadvantage is you’ll have to pay for mortgage insurance, which can increase the amount of your monthly payments.
The U.S. Department of Veterans Affairs (VA) offers a unique loan program to military service members and their families. Like the FHA program, these mortgages are guaranteed by the federal government. This means that the VA will reimburse the lender of any losses that occur from the borrower. A major perk of this loan is that borrowers can receive 100 percent financing for the purchase of a home, meaning there is no down payment to worry about.
USDA/ RHS Loans
The U.S. Department of Agriculture (USDA) offers a loan program for rural borrowers who meet certain income requirements. This kind of mortgage loan is offered to “rural residents who have a steady, low or modest income, and yet are unable to obtain adequate housing through conventional financing.” In order to quality for this type of loan, your income must be no higher than 115 percent of the adjusted area median income.
If you have any questions about which loan type is best for you, contact American Dream Realty in Woodland Hills today!