Navigating a residential home purchase is a complex proposition. From the time the homebuyer submits an offer until they close on the property, they must successfully complete multiple steps in the transaction.
If the homebuyer has sufficient financial resources, they may pay cash for the home. In the majority of cases, however, buyers are compelled to make a down payment and finance the remainder of the purchase price via a residential mortgage.
Private equity principal Mark Hauser explains how mortgages work and discusses the major types of mortgage loans. He also details the mortgage qualification criteria, which vary with specific lenders and mortgage loan types.
Snapshot of a Residential Mortgage
In the United States real estate market, a residential mortgage is a loan enabling one or more adults to finance a property purchase. Once the homebuyer puts forth a cash deposit, the lender agrees to forward the remainder of the purchase price to the seller (via their realtor).
To repay the advanced funds, the homebuyer makes monthly payments for an agreed-upon length of time. The payments include the balance owed plus interest. The lender will likely offer the homebuyer a choice of mortgage lengths (or terms). A longer-term mortgage will result in lower monthly payments. However, the homebuyer will be charged additional interest, increasing the total mortgage cost.
Finally, a residential mortgage is a secured loan. If the homebuyer cannot stay current with their mortgage payments, the lender can legally repossess the property. However, Mark Hauser notes that some lenders will work with the buyer to arrive at more affordable terms, thus avoiding foreclosure.
Four Most Common Types of Mortgage Lenders
A 21st-century homebuyer can choose from multiple types of mortgage lenders. Although some of these companies cater to a specific market, others offer mortgage products that appeal to a wide swath of the marketplace. Mark Hauser highlights the four most common types of mortgage lenders.
National, Regional, and Community Banks
Banks are the most frequently used type of mortgage lender. Whether a homebuyer lives in a large city, a small town, or a rural area, they’ll have access to one or more banking institutions.
National Banks
Regardless of the homebuyer’s location, a national bank will likely offer multiple types of mortgage loan products. Mark Hauser states that these multifeatured financial institutions also simplify the mortgage application process with streamlined digital tools.
Regional Banks vs Community Banks
Regional banks typically cover an expansive service area that often includes multiple states. These banks frequently operate a substantial number of branches. In contrast, community banks usually offer services in one metro, suburban, or rural area.
Compared to community banks, regional banks typically have more assets on the books. To illustrate, regional banks’ assets are usually in the $1 billion range compared to community banks’ $500 million.
Member-Run Credit Unions
Credit unions are known for offering many banking services. However, these non-profit financial institutions cater to members of a specific group or organization. Only members of the group can use the credit union’s services.
Larger credit unions, such as a state employees’ credit union, operate multiple branches and use updated technology. Smaller credit unions may have limited locations and little technological resources.
Although credit unions offer mortgages, a specific institution may need to team up with another lender to offer a specific type of mortgage loan. In addition, credit unions (like banks) differ in their loan offerings, products, and fee structures.
Professional Mortgage Brokers
Homebuyers interested in specific mortgage terms may want to consider working with a mortgage broker. This independent business owner looks for the loan and terms that best meet each buyer’s needs. Private equity expert Mark Hauser explains that brokers work on commission. They earn income when they successfully match a homebuyer to the right loan.
The mortgage broker’s services end when the homebuyer begins making their monthly payments. Once the mortgage transaction is concluded, the homebuyer can expect to be contacted by a different mortgage service associate. In contrast, some banks continue in-house servicing customers’ loans while other banks sell the mortgages to another company.
Online Mortgage Lending Companies
An online mortgage lender specializes only in residential mortgages. Therefore, these businesses are unlike banks and credit unions, each of which provides their depositors with additional services.
Online mortgage lenders are known for their willingness to work with homebuyers with low credit scores. These lenders also offer multiple loan options and low interest rates. However, online mortgage lenders frequently don’t offer tailored customer service. This can be an issue for first-time homebuyers who aren’t familiar with the lending process.
5 Types of Residential Mortgage Loans
United States consumers can typically choose from five types of mortgage loans. Each loan offering may be the best choice for a specific segment of the marketplace.
Conventional Mortgage Loan
A conventional mortgage loan can be used to purchase a primary or second home or an investment property. Homebuyers with good credit scores, and who can make a hefty down payment, may find that a conventional loan is the best option.
Compared to other mortgage types, conventional loans have slightly higher interest rates but have lower overall borrowing costs. If the loan is backed by Freddie Mac or Fannie Mae, the homebuyer may only need to pay three percent down.
However, financial expert Mark Hauser emphasizes that conventional loans often require a minimum FICO score of 620. Homebuyers must provide extensive documentation prior to loan approval. If the buyer puts down less than 20 percent of the home sale price, they will likely be required to pay for private mortgage insurance (or PMI).
Jumbo Mortgage Loan
A jumbo loan is geared to homebuyers with excellent credit who plan to purchase a higher-priced home. Jumbo loans feature competitive interest rates. In fact, notes Mark Hauser, jumbo loans may be the sole financing option in higher-priced communities.
However, jumbo loan homebuyers must usually have a 700+ FICO credit score. A down payment of 10 to 20 percent (or more) is often required. The buyer must produce stronger documentation, including proof of substantial assets in cash and/or savings accounts.
Fixed-Rate Mortgage Loan
Many homebuyers are familiar with fixed-rate mortgage loans that keep the same payment for the entire loan period. Fixed-rate loans generally carry a 15- or 30-year loan term. However, some lenders allow borrowers to choose a loan term from eight to 30 years. If the homebuyer expects to stay in the home for five to seven years, and wants a loan payment that doesn’t change, a fixed-rate loan may be the best choice.
However, a fixed-rate loan also has two downsides. These rates are often higher compared to adjustable-rate mortgages. If interest rates drop, the homebuyer must refinance to get the lower rate.
Adjustable-Rate Mortgage Loan
An adjustable-rate mortgage (or ARM) loan’s interest rate rises and falls with market conditions. Some ARM loans initially feature a fixed interest rate before the loan switches to a variable interest rate. Homebuyers who only plan to stay in their homes for a few years may find that an ARM best suits their needs.
However, an adjustable-rate mortgage carries a significant element of risk. A homebuyer may not be able to afford the higher monthly payments, leading to a potential loan default. In addition, falling home values could make it more difficult to refinance the loan or sell the property before the loan switches to a variable-rate structure.
Government-Insured Mortgage Loan
A government-insured mortgage loan may work best for homebuyers with lower credit scores and little down payment funds. Although the United States government doesn’t actually lend money to homebuyers, three government agencies reduce lenders’ risks by guaranteeing certain loan types. The Federal Housing Administration (or FHA), the U.S. Department of Veterans Affairs (or VA), and the U.S. Department of Agriculture (or USDA) are the participating agencies.
A government-insured mortgage loan has less-stringent credit requirements, and homebuyers can qualify with a small down payment. First-time and repeat buyer mortgages are eligible for these loans. A VA-backed homebuyer doesn’t need a down payment, and they won’t have to pay for mortgage insurance.
On the downside, homebuyers who want a government-insured loan must actually reside in the property. FHA-backed loans often have lower loan amounts than conventional mortgages. FHA loans also have required mortgage insurance premiums that cannot be rescinded. Higher borrowing costs and extensive required documentation are other potential issues of government-backed loans.
Mortgage Loan Qualification Requirements
Although every lender maintains its own qualification standards, SoFi Bank lists nine universal loan approval requirements. First, the property type and proposed use are key considerations. The mortgage type also figures into the qualification process.
Next, a down payment is necessary, although it varies with the mortgage type. The homebuyer’s credit score provides an indication of their creditworthiness. The applicant’s income, their debt-to-income ratio, and their assets are also important factors.
The homebuyer’s timely submission of required documentation is also key. Finally, Mark Hauser states that mortgage prequalification or preapproval may help to streamline the process.
