Home Loans from A to Z - Getting the Basics
From Amortization to regulation Z, there are many terms to deal with when shopping for a home loan. There are different types of loans, lenders, payment plans, and terms.
You may want to finance a home purchase or renovation, refinance your mortgage loan, or borrow money against your home. A home loan is used for all of those purposes. A home loan means that you provide real estate as collateral. That means, if you do not make your payments, then the lender can sell the property to recuperate their money.
In order to help you get started on your path to find the right home loan for your situation, you will learn about these important features:
- Types of Home Loans
- Two Key Terms: LTV, DTI
- Tools to help you find the home loan right for you
Type of Home Loans
The different types of home loans depend on the reason you are taking out a mortgage. The main reasons and types are:
- Purchase Mortgage Loan: Used to purchase a house or condominium.
- Refinance Mortgage Loan: Used to refinance your current mortgage.
- Home Equity Loan (HEL), Home Equity Line of Credit (HELOC), or Cash our refinance: Used to take out equity (cash) from your house. Borrowers take home equity loans (or cash-out refinances) for all kinds of reasons, including debt consolidation, purchasing big-ticket items, paying for college, or purchasing luxury items.
Here are other ways home loans are classified:
Interest Rate: There are two type of home loans based on the type of interest rate:
- Fixed interest rates (Fixed Rate Mortgages or FRM): Fixed rates offer you a stable constant payment over the entire life of your loan.
- Adjustable interest rates (Adjustable Rate Mortgage or ARM). An adjustable rate is tied to an index (usually 1 year T-bill or 1 year USD Libor rate) plus a fixed margin. An ARM comes with a low interest rate for then initial period, but carries the risk
Length of the loan: Home loans are generally long-term loans. The most common are:
Two Key Terms: LTV, DTI
Almost all loans require a minimum FICO credit score and/or are priced based on your FICO score. Two special features that relate to home loans are your LTV (relating to your property) and your DTI (relating to your housing expenses), as follows:
LTV (Loan to Value): No matter what type of home loan you look for, the lender evaluates your LTV ratio.
- Calculate LTV: You can calculate your LTV by dividing your loan balance by the value of your home. Although an online or real estate estimate helps you get a ball park figure, your lender uses an appraised value of your home. (Don’t use your property tax value). For a home purchase loan the lender takes the lower value between the purchase price and the appraised value. For an home equity loan the lender will use an appraised value.
- LTV Limits: In general, home loans are limited to 80% LTV limits without mortgage insurance and 90-95% with mortgage insurance. FHA home loans go up to 97.5% financing and are an attractive option if you have a small down payment or high LTV ratio. In general, home equity loans have more restrictive LTV limits. There are special refinancing programs for home loans like the HARP refinance and the FHA streamline refinance with unlimited LTV.
DTI (Debt to Income): Lenders evaluate your credit worthiness based on your income level. When applying for a home loan the lender calculates your DTI as follows:
- Front-end DTI: Your front end DTI is calculated by dividing your monthly housing expenses (mortgage payment of principal and interest, property tax, property insurance, homeowners fees) by your monthly gross income.
- DTI (total or back-end): Your total DTI is calculated by adding all your monthly housing expenses (like you did for your front-end DTI) plus all your reoccurring monthly debt payments (credit cards, student loans, auto loans, installment credit) by your gross monthly income.
- Acceptable ratios: Underwriting requirements (lenders lending rules) vary and are very technical. FHA loans for example allow for 31% front-end and 43% total DTI ratio. Conventional loans vary with the acceptable limits for top rates at 36% total DTI ratio. Fannie Mae allows for up to a 45% DTI ratio. If you have problems, make sure to work closely with your lender.
Tools to help you find the Home Loan Right for You
Going through A to Z in a few steps is impossible. Learning all about home loans in a brief article is also impossible. Bills.com offers you many detailed articles about different types of loans, how to qualify for a loan, mortgage rates and many other subjects.
Bills.com also offers you some cool calculators and tools to help you find the best home loan, including:
- Mortgage Affordability Calculator: This calculator helps you determine how much house you can afford to buy based on your income, debt payments (house related and non-house related), and available down payments. The calculator shows you the maximum payments on a 30-year FRM home loan, based on current mortgage rates.
- Refinance Calculator: This is a great tool to aid you in deciding if refinancing is a good idea. The calculator evaluates your refinancing choices based on your goal (save money, lower payment) and different loan options using current mortgage rates.
- Mortgage Payment Calculator: This is a simple tool to help you calculate how much your monthly payment will be based on different interest rates, loan amounts, and repayment periods.
Purchasing a home and financing a home is a major financial event. You don’t have to know the whole dictionary from A to Z, but take the time to learn about your options and find the home loan best suited to your needs.