Home Financing
Home Financing: What is a Home Loan?
To purchase a home, buyers can either purchase the home upfront in cash, or finance the purchase with a home loan (also known as a mortgage).
A home loan is an agreement between the buyer and a mortgage lender (bank or other financial institution) for the buyer to borrow money to buy property. This agreement gives the lender the right to repossess the home if the buyer does not meet the mortgage terms (repay the borrowed sum with interest).
To determine if and how much to loan out, the lender will assess the buyer’s credit history, debt-to-income ratio (DTI), and current assets in comparison to the down payment, purchase price, and home appraisal value.
Types of Home Financing: Pros and Cons
There are many ways of financing a home purchase. The buyer can buy in cash; with a conventional, fixed-rate, or adjustable-rate mortgage; or a government-backed VA, FHA, or USDA loan.
Type of Financing
Pros
Cons
Cash
- No interest
- No monthly payments
- No lender-associated closing costs
- Faster closing process
- Higher likelihood of offer acceptance
- Buyers with higher interest rate debt may prefer to use their cash to pay off that debt and instead use a lower interest rate mortgage to buy the home
- Can render some buyers “cash poor”
Conventional
- Best for those with stable income and strong creditNo monthly payments
- Most common type of mortgage
- Minimum down payment of 3%
- Stricter requirements on DTI
- Stricter minimum credit score (620)
- Down payments of less than 20% require private mortgage insurance (PMI)
- Possibility of higher interest rates than government-backed loans
Government-Backed
- Best for those who do not qualify for conventional loans
- Possibility of lower interest rates and down payments
- Lower qualification requirements
- Specific eligibility criteria
- Possibility of insurance premiums which can result in higher borrowing costs
*Government-Backed Loans are loans insured by government agencies, meaning they are less risky for lenders because the government is responsible in case of default. They are best for buyers who do not qualify for conventional loans.
Types of government-backed loans include:
- Insured by the Federal Housing Administration
- Minimum credit score of 580 (500 with >10% down payment)
- Minimum down payment of 3.5%
- Maximum DTI of 43%
- Insured by the Department of Veterans Affairs
- For those who qualify with service requirements in the Armed Forces or National Guard
- Minimum 0% down payment for those who quality
- Lower interest rates than most other loans
