3 Smart Loan Options For Your Next Home Purchase or Refinance

smart-home-loan-options

If you are lucky enough to have a large sum of cash set aside to buy your next real estate property outright, then congratulations! But for the rest of us, we’ll need to finance our next home purchase with a mortgage or some other type of creative financing.

Then be able to pay it all back over a 1, 5, 10 or a 30 year period.

Shopping around and applying for financing that has good terms can be a real pain. Below we’re going to review the top 3 financing options that exist for residential real estate (i.e., condo, townhome, house, 2-4 unit multiplex.)

If you have not already, review my other guide regarding: How To Get Qualified and Approved For A New Mortgage Home Loan

Most of the below options can you assist you in

Let’s Begin!

Downfall of Putting Less Than 20% Down

Any down payment that is lower than 20% will require Private Mortgage Insurance (PMI), which means you’ll have a higher monthly payment. Here’s more information on what exactly PMI is: What Is Private Mortgage Insurance?

There might be a way to use a second mortgage to finance part of the down payment eliminating PMI, but you’ll need to work with the lender on that strategy.

An example is using 10% down cash, then a second loan for the other 10% equaling 20%. A mortgage broker becomes extremely beneficial for working out this strategy, and it can save hundreds of dollars every month.

Doing creative financing can also help eliminate PMI.

Option #1: First Time Home Buyer Programs

First Time Home Buyer programs make it easy to buy a home with little money down. They also have more relaxed lending requirements. The most well known first time home buyer program is provided by the Federal Housing Authority or FHA.

It’s the first program I used for my first home purchase, and I think it’s the best one out there. Its most commonly referred to as an FHA Home Loan.

Some Highlights of this loan include:

  • A minimum credit score above 580 as part of the basic qualifications. But honestly, in the real world, I’d shoot for at least a 620 score with no bad marks on your credit whatsoever.
  • You can buy with only 3.5% down. Compare that to the traditional 10 or 20% required for a conventional mortgage.
  • A higher income-to-debt ratio is sometimes allowed, beyond the conventional loan limit of 30-40%.
  • There are some strict lending requirements relating to the condition and type of property you can buy with an FHA Loan. You can review those requirements here: FHA Loan Requirements

FHA is not the only first time home buyer option out there. Below are some more programs for you to review.

Other Programs include:

Freddie Mac & Fannie Mae – Both are government sponsored entities that work with small and large lending institutions to loan out money for buying homes. They help facilitate loan programs based on conforming guidelines from the government. The programs typically require a low down payment too. They do not directly lend out money to the borrowers. To learn more about the differences, check out the following article: Freddie Mac vs. Fannie Mae

USDA loan – If you’re considering a property in a rural area, this type of loan just might work for you. It can be used for purchasing, building, or repairing your new home.

VA loan – The VA loans don’t always require a down payment and are available exclusively to most members of the military. Including all Veterans, National Guard Members,  and Reservists.

Good Neighbor Next Door – If you’re a teacher, police officer, firefighter or an emergency medical technician (EMT) you may qualify for this program from HUD. They’ll offer a substantial 50% discount if you buy a qualifying home in the community you serve.

Energy-efficient mortgage (EEM) – If your borrowing money to purchase or remodel a home (or multiplex) that is energy efficient you’ll get some perks with this mortgage program. The biggest perk being that loan limits may be exceeded if the extra cost relates to the property being energy efficient.

FHA Section 203(k) – If you’re buying a fixer-upper, this program can allow you to finance up to 35k of the repairs right into your first mortgage. Wow, that would really help out with a neighborhood revitalization if everyone did that.

Local Grants and Programs – Your realtor or mortgage broker may know of some local grants or programs that might be available in your city to help purchase a property.

Quick tip: I highly recommend you educate yourself on the basics of financing and loans. Research the rules and regulations very carefully for each one of these programs. Especially if you’re renting out rooms, or eventually you want to rent the entire property out. It might be against the rules, or there may be some restrictions.

Next up, we discuss Conventional Financing; You’ll need this type of financing in case you don’t qualify for any of the programs in this option.

Option #2: Conventional Financing

You can use conventional financing for buying or refinancing a home. Typically the best program is a 10, 15, or 30-year fixed rate loan where the payment can never increase, and your principal is paid down in full by the end of the term.

There are other conventional loans out there called option arms (aka Pick A Payment Loan). These start off at a fixed rate at the beginning of the loan, normally the first 3 or 5 years.

Then the interest rate is variable and could cause a higher monthly payment. While the terms of a variable rate loan can be appealing in the beginning, I would not recommend them as a long-term option.

With all conventional home loans, the buyer will usually need to have a credit score above 680. It’s possible to get a conventional loan with a lower credit score, but the lender may raise your interest rate or require a higher down payment to qualify you.

While most conventional loans do require a higher down payment, there might be some zero down options (or low down payment) out there if you look hard enough, but those programs are rare and sometimes don’t have the best terms.

Quick Note: You’ll need to have a decent debt to income ratio of 30-40% so make sure you know how much house you can afford.

Since conventional loans are not backed by a government entity, they are also more flexible on the condition of the property you’re buying as a homeowner.

Remember! It’s always best to shop around for this type of loan as the terms can vary between lending companies.

Option #3: Creative Financing (and purchases)

With so many options available it’s easy to get lost in the world of Creative Financing. For your average consumer it can be confusing and a bit intimidating, to say the least.

But with a little knowledge and some time to think things through, it’s actually pretty straightforward and not much different than the previous two options.

Creative financing is the term for any financing that is not conventional through a regular mortgage lender. You can read the entire meaning of it here: Wikipedia Article on Creative Financing

Here’s a brief summary of what I know and have heard of

Hard Money and Private Loans – These loans are provided by a private non-traditional lender. There are higher interest rates and much stricter loan to value ratios. Generally, you’ll avoid this for a long-term purchase. But for short time house flips or for purchasing a foreclosure, they work great! There’s also portfolio private loans, check out this article to find out more about that option. What is Portfolio Private Lending?

Financing through a Short Sale – Short Sales are very popular when a property can’t be sold for more than the balance of the mortgage owed on it, and the property owner is having a financial hardship. Normally the owner will be behind at least three payments (90-day default). A homebuyer (or investor) could buy the property for a discounted price from the distressed seller. But the lender that is holding the existing mortgage has to approve the sale.

Lease Option (aka Rent to Own) – This allows a potential buyer to get ‘control’ of a new property, but not own it directly. Financing will be provided by the existing owner’s lender. Terms will be negotiated to have an option to buy the property at a future date, normally up to a two year period in my experience.

Subject To – A buyer will get deeded to the property and then assume payment obligations on the existing loan. The transaction is Subject To the existing mortgage. There could be some conflicts with the lender with this type of transaction, but people do it anyways.

Seller Financing – If an owner of an existing property has enough equity, they can offer the buyer financing directly and collect payments on a first or second note until it’s paid in full. This method is very popular where the buyer does not have enough for a down payment. The owner provides 20%, and the bank provides 80%.

401k Loan – Sometimes people will borrow against the money in their 401k plan. This helps get a down payment etc. I’m not an expert on these types of loans, but I don’t think I’d ever consider taking money from my retirement plan.

Crowdfunding / Peer to Peer – There are crowdfunding and peer to peer lending sites where you can raise funding for your real estate purchases. Some websites you can use for this is Lending ClubFund Rise, and Patch of Land.

In the end, I would always do extra research when doing creative funding of any kind. Review the terms very very carefully. Have an exit strategy either to sell the property or refinance it into a better loan if you’re thinking of any long-term plans.

Always seek out professional help from a trustworthy broker or real estate attorney. A tax advisor is also recommended!

Lastly, Know All the Terms of Your Loan

You’ll want to know all of the terms of your new loan before signing an agreement to pay it back. Terms such as the annual interest rate (or APR), down payment requirements, the length of the loan, points, and premium mortgage insurance rates (if putting down less than 20% of the purchase price) so keep your eyes open!

Never be afraid of Googling a term or asking a direct question about a loan item that is not clear. A summary of all the closing costs (loan items) should also be provided in advance; it’s called a Good Faith Estimate.

Never sign the final papers without reviewing a Good Faith Estimate first!

Final Thoughts

If at all possible just stick with First Time Home Buyer Programs and Conventional Financing for the best deals on interest rates etc. Buying a property is a long-term investment/purchase for most people.

The only time you should use Creative Financing is if you’re getting a home and can’t finance it with Conventional Financing.

Cheers!