Almost everyone who buys a house borrows money to pay for it. This is done most often through a note and mortgage, but it is sometimes done by contract for deed.
Methods of Financing
A mortgage involves making the house itself the security for the loan. The buyer receives the deed from the seller and becomes the legal owner. The buyer gives the lender the right to foreclose and obtain possession of the house if he/she fails to repay the loan. This is called a mortgage. Payments are generally made monthly, which include part of the principal and part of the interest.
A contract for deed is a contract where the seller, in effect, lends the buyer the money to buy the house. The seller remains the legal owner of the property as security until the contract is paid. Contract for deed sales are usually made when a mortgage loan cannot be obtained, and the buyer and seller are both eager to do business.
Rate of Interest. Interest rates vary depending upon the nature of the loan and the economic conditions. Shop for the best possible rate available when considering a purchase of real property.
Length of Mortgage Period. The longer the mortgage, the lower the monthly payment. However, the total interest paid is more. Most home mortgages are for 15 to 30 years. Some loans are obtained with a “balloon” payment, which permits smaller monthly payments for a time period, and then the unpaid balance is due.
Acceleration Clauses. One should pay careful attention to what will happen if payments are not made timely. In many cases, the failure to meet payment requirements causes the entire debt to become due.
Prepayment Clauses. This permits paying off the mortgage before the end of its term. This right is necessary if refinancing is to be possible, or if the borrower wants to sell before the mortgage is paid. Some lenders charge a penalty for prepayment.
Due-on-Sale Clause. If a mortgage contains this clause, the mortgagor is required to pay off the mortgage debt, at the lender’s option, when the property is sold. This eliminates the possibility of the buyer assuming the mortgage without the lender’s consent.
Insurance and Taxes. The borrower will be required by the lender to maintain insurance on the property as a protection against loss. The borrower may be required to prepay the property taxes to the lender, either in a lump sum or on a monthly basis as a part of the payment to the lender. The insurance premium may also be part of the monthly payment.
Down Payment. In most cases, to obtain a mortgage loan, a down payment is made. The amount depends upon the lender and type of loan.
Fees. When a borrower asks for a mortgage loan, the lender incurs a number of expenses, including such things as the time the loan officer spends interviewing the borrower, office overhead, the purchase and review of credit reports, title searches, legal and recording fees, and so on. The general practice is for lenders to charge 1% to 2% of the amount of the loan. This is commonly known as the “Origination Fee.”
Points. Points are percentage points of the amount of the loan. One point = 1%. Points are charged to raise the lender’s yield. For example, a lender may be willing to offer an interest rate that is lower than the general market rate and in return require the borrower to pay “points”. The points are payable at closing.
Adjustable Rate Mortgages. Adjustable rate mortgages are generally originated at one rate of interest, with the rate fluctuating up or down during the loan term base upon economic conditions. Generally, interest rate adjustments are limited to one each year, and there are a maximum number of increases that may be made over the life of the loan.
Types of Loans
Real estate loans today are categorized into three general types:
Veterans Administration Loan. The main purpose of the VA loan is to assist veterans in financing the purchase of reasonably priced homes, including condominium units and mobile homes, with small or no down payments. The financing is limited to owner-occupied residential (1 to 4 family) dwellings.
Federal Housing Administration Loan. Purchasers wishing to use an FHA-insured mortgage must meet certain criteria. A charge will be made to the borrower as the premium for the FHA insurance. This protects the lender from loss. The property must be appraised by an FHA appraiser before the loan is made.
Conventional Loan. This type of loan is not insured by the government or guaranteed. The risk is therefore higher for the lender, which is reflected by higher interest rates and a larger down payment requirement. Lenders establish specific terms of the loan, and can vary according to market conditions, consumer needs, and state regulations.