5 types of mortgage loans for homebuyers

The odds are that buying a home will be the largest purchase you ever make. As a result, you want to make sure that you’re choosing the type of mortgage that makes the most sense for your financial situation. You also want to make sure that your mortgage won’t cost you more than it needs to. To accomplish this, it is important to work with a one-stop shop lender that will offer you the best rate and terms available to you.

With the right amount of research and consideration, you can buy your dream home without giving up an arm and a leg. 

What Is a mortgage and how does it work?

A mortgage is a loan provided by a lender for the specific purpose of purchasing a home. These loans are incredibly common as home prices can run extremely high, and it can be difficult for many people to pay hundreds of thousands of dollars up-front in cash. 

Instead of paying all that money yourself, you partner with a lender where they pay the cost up-front, and you pay them back monthly. 

Like any type of loan, a mortgage loan comes with a lot of requirements to protect lenders. After all, their overall goal is to get their money back. For that reason, you are required to go through an application process to ensure that you’re a trustworthy borrower and have the means to pay them back. 

Mortgage terms you need to know

The world of mortgages involves various terms that can be confusing and overwhelming for first-time homebuyers. After all, how can you possibly know what type of mortgage loan is right for you if you don’t understand the key terms and definitions being used throughout the process? 

So before we dive into the pros and cons of some of the different mortgage options out there, we are going to briefly cover some of the crucial mortgage terms you need to know:

• Principal, Interest, Taxes, and Insurance (PITI): The four components of your monthly mortgage payment are principal, interest, taxes, and insurance. The “principal” covers the actual value of the loan itself. “Interest” relates to the additional percentage of interest that you pay to the lender. “Taxes” relates to the monthly cost of property taxes. “Insurance” refers to homeowner’s insurance or private mortgage insurance (PMI). 
• Private Mortgage Insurance (PMI): A type of mortgage insurance typically paid to the lender when your initial down payment is less than 20%. You usually have to pay PMI until you have paid off 20% of the loan. 
• Down Payment: When buying a home, you generally have to put a certain amount of money down up-front to bring down the overall cost of the loan and perhaps earn a lower interest rate. A down payment of 20% of the home’s value is usually recommended, although other loan options allow you to put less money down. 
• Escrow: An account set up by the mortgage lender allowing you to pay into property taxes and homeowner’s insurance monthly rather than getting a large bill once a year. 
• Annual Percentage Rate (APR): Your APR relates to the total cost of borrowing money from a lender. This term covers fees that go beyond the basic interest rate. 
• Debt-to-Income ratio (DTI): Your DTI is the total of all your monthly debt payments divided by your gross monthly income. Many lenders use this calculation to determine your mortgage qualification and eligibility. Many lenders prefer a DTI below 36%. 

Types of mortgage loans for homebuyers

Now that you better understand some of the key mortgage terms, we can cover the different types of mortgage loans available to homebuyers. Each option is different, and what works for some people may not work for others. 

As a result, keep your unique financial situation in mind when considering the pros and cons of each type of mortgage loan. 

Fixed-rate mortgage

Fixed-rate mortgages are loans that maintain the same interest rate throughout the entire life of the loan. As a result, you pay the same monthly payment from start to finish. 

Fixed-rate mortgages can come in terms of 15, 20, or 30 years. You may rack up more interest in a longer-term fixed-rate mortgage, and it can take you more time to build equity in your home. 

Adjustable-rate mortgage

Adjustable-rate mortgages are loans that have a fluctuating interest rate depending on the market. These loans typically start with a fixed rate for the first few years before becoming adjustable. 

This type of loan is considered riskier than a fixed-rate mortgage, but it has the potential to save you a lot of money in interest. 

Interest-only mortgage (IO)

An interest-only mortgage only requires the borrower to make interest payments on the loan for a certain amount of time, up to several years. This is different from typical loans which require payments on both the principal loan and interest. 

Interest-only payments can last the entirety of the loan period, with the borrower paying their principal loan amount in full at the end of the lending period. They can also be offered as an option for a specific time period or given as an option as-needed. In this case, they’re a type of adjustable-rate mortgage. 

Full documentation mortgage

A full documentation loan requires the borrower to verify their income and assets through official documents like W-2 forms, paystubs, tax returns, profit and loss statements, veteran benefit statements, and social security statements. 

Full documentation loans can even go so far as to check investment statements, student loans, credit card bills, child support, motor vehicle titles, or any other official documents that give insight into their financial standing. Having a stellar financial record can help you negotiate a lower interest rate on your loan.

Full documentation mortgages can be fixed, adjustable-rate, or interest-only depending on your needs and the needs of your lender.

Low documentation mortgage

Low documentation loans are similar to full documentation mortgage loans, but they’re better suited to self-employed individuals or business owners who have fluctuating income and cannot prove their ability to repay through W-2s, tax returns, or pay stubs. Individuals qualify through different means such as high credit scores, asset ownership, or large investment accounts. 

Like full documentation mortgages, low documentation mortgages can be fixed, adjustable-rate, or interest-only.

How to Qualify and Apply for a Mortgage?

With this information in mind, you may be wondering how to qualify and apply for a mortgage loan.

Here is what you’ll need to qualify and apply for a mortgage loan:

• Full Documentation: To qualify for a full documentation loan, you’ll need a decent credit score around 600, a minimum income starting at $20,000 for some lenders, a debt-to-income ratio under 40 percent, and collateral. However, these requirements will change depending on extenuating circumstances and your lender. 
• Low Documentation: To qualify for a low documentation loan, you’ll need a great credit score above 720 with a clean credit history, large bank or investment accounts, and/or proof of assets. You’ll likely be asked to make a larger down payment between 20 and 40 percent. 

Your interest rates will be determined based on the documentation you provide.

The mortgage application process can be very tedious and overwhelming if you’re not sure what to expect. However, if you are proactive and plan, it can be a seamless process. 

Here are some things you should expect to provide to a lender when applying for a full doc mortgage loan:

• Two years of W-2s from your employer to show your annual income
• Pay stubs from the past 30 days from your employer to show your monthly income
• Two to three years of income tax returns to verify income and deductions
• Two to three years of 1099 Forms if you’re self-employed or a freelancer
• Two to three months of bank statements to verify income, savings, and down payment 
• Two to three months of retirement and investment account statements 
• Credit verification will be run through your lender with your permission

Applying and qualifying for a mortgage can seem like a lot of work -- but just take a systematic and calculated approach. It will all be worth it in the end when you get the keys to your new home. 

Final Thoughts on Mortgages

Choosing your type of mortgage is a huge decision. However, you can determine the best type for your situation with the proper research and effort. 

If you have any questions along the way, feel free to reach out to the lending experts at Vaster for advice and expertise that will save you time and money. 

Sources:

Mortgage Definition | Investopedia

Mortgage Glossary – Mortgage Terms & Definitions | Bank of America

Mortgages | USA.gov