By Dr. Ana Machuca, Full-Time Faculty
Published February 2014
There are many challenges you can encounter when buying a home for the first time, for example: What type of loan is best for me? How much down payment should I put down? How much home can I afford? What are closing costs? And what is included in your monthly payment? In this article we will address the first two questions in detail and follow up on the remaining questions in our next article.
How much down payment should I put down?
The amount of money to put down depends on your particular situation and the loan chosen. Some loans require that you pay a higher down payment than others. For example, you can get into a Federal Housing Administration (FHA) loan for 3–4 percent down, while a conventional loan usually requires a minimum of 20 percent down. A couple of items to keep in mind is that if your loan-to-value (LTV) is less than 80 percent, you will be required to pay something called "private mortgage insurance (PMI)" as part of your monthly payment until the LTV reaches 80 percent. My recommendation is that if you have the money available for a down payment, use it to avoid paying interest in the long run and avoid paying the PMI. Another option is to get two loans, a conventional loan for 80 percent of the price which will be kept long term, and a shorter term loan which will be used as their 20 percent down payment. This option is recommended if you are waiting for money from the sale of another home or another asset.
What type of loan is best for me?
There are several types of loans available to buyers, such as: fixed-rate mortgage, adjustable rate mortgage (ARM), FHA mortgage, and Veteran's Affair (VA) mortgage.
A fixed-rate mortgage is a mortgage where the rate of interest paid is fixed for the duration of the loan. These loans come in 10-, 15-, 20-, and 30-year durations. The shorter the duration of the loan, the higher your payment will be, but the time to pay off the loan will be shorter and the amount of interest paid will be less.
An ARM is a loan where the interest rate is adjusted throughout the loan period. People tend to want these types of loan when they want a lower payment now and do not care if the payment goes up later because they will have a higher income to pay for the loan. With this type of loan you could afford to buy a higher priced home now instead of later. But, beware because the interest rate could jump as much as 2 percent in a given year depending on the stipulations of the loan and economic conditions.
An FHA Mortgage is not a loan but a program sponsored by the federal government to encourage homeownership. The FHA will provide assurances of payment on your behalf to lenders that would otherwise not approve you. Meaning that if you do not pay the loan, FHA will step in and pay it to the lender, but in turn they will take your house from you. When you have an FHA loan you need to pay PMI as part of your monthly payment because it is usually less than 80 percent LTV. That is how the FHA will be covered in the event you default on the loan. The cost of PMI will vary with the outstanding loan amount each year and is only payable until the loan reaches 80 percent of value. In some cases with an FHA loan, your down payment can be a little as 3 percent of the price of the home. You do have to apply to the government and there are usually some income restrictions.
A VA mortgage is a loan given to any person and eligible spouses who have ever served in the military. VA Home Loans are provided by private lenders. VA guarantees a portion of the loan, enabling the lender to provide you more favorable terms (http://www.benefits.va.gov/homeloans).
Stay tuned for the next article that will address additional challenges that first time homebuyers face such as: How much home can I afford? What are closing costs? What is included in my monthly payment.
Dr. Ana Machucais a full-time faculty member at Kaplan University. The views expressed in this article are solely those of the author and do not represent the view of Kaplan University.