Your Home Loan Toolkit: Creative Financing Examples

The traditional fixed-rate mortgage isn’t the only home loan option available to people looking to buy a home in Austin. In fact, there are many types of home loans in Texas. We spoke to a few financial experts about the differences between fixed vs. adjustable rate mortgages, as well as a variety of creative ways to finance a home. Keep reading for more insight.

What are the different types of home loans?

When it comes time to start your home search, you’ll want to know the best financing option for you so you know how much home you can afford before beginning your search. Finding a home is exciting, and the process of deciding on what loan type to get or what company to go with can go much smoother if you’ve done some research.

There are a few major different types of mortgages that homebuyers choose, which are:

  • Fixed-rate mortgages – these loans remain the same for the life of the loan, so you’ll always know what your monthly payments are.
  • Adjustable-rate mortgages – with these loans, the interest rate usually starts out low during the introductory period and then changes to be higher or lower. They are displayed like this, for example: a 5/1 ARM. In this case, the introductory period lasts 5 years, and then the interest rate can change every year after that. The change is dependent on a market index (like the yield on the one-year Treasury bill) which is noted on your loan.
  • Conventional loans – these can be good if you have a higher credit score, and the borrowing cost can be lower even when interest rates are high. These can be fixed or adjustable, and they differ because they are not government-backed and tend to be harder to qualify for.
  • Government-insured loans – these are insured by the government, so lenders have less to risk if you don’t pay on time (FHA loans fall under this category).
  • VA loans – according to the U.S. Department of Veteran Affairs, VA home loans are designed to help servicemembers, veterans, and eligible surviving spouses become homeowners. The VA guarantees a portion of the loan, enabling the lender to provide you with more favorable terms.

What’s the difference between a fixed vs. adjustable rate mortgage?

As the names imply, fixed rates stay the same while adjustable rates change. Fixed rates protect you from sudden increases in your monthly mortgage payment if rates rise. “ARMs typically come at a significantly lower rate than fixed-rate mortgages, which supports homebuyers with additional buying power in today’s highly competitive purchase market,” says Phil Shoemaker, President of Originations at Homepoint.

ARMs tend to become more popular when interest rates are high, and there are different types of ARMs. These include 3/1 ARMs, 7/1 ARMs, and even 10/1 ARMs, where the first number is the introductory period and the second number means that it can change after every year. Mortgage lenders take an index (an interest rate that is tied to a specific benchmark) and set a margin of points that does not change.

According to Bankrate, “if the index is 1.25 percent and the margin is 3 percentage points, they are added together for an interest rate of 4.25 percent. If, a year later, the index is 1.5 percent, then the interest rate on your loan will rise to 4.5 percent.”

How do you decide if an ARM is good for you?

Adjustable-rate mortgages garnered a bad reputation during the housing market crash, but there are some reasons people might choose them. Borrowers choosing an adjustable rate mortgage should note that lenders have become more stringent and there are protections in place that buyers didn’t have in the early 2000s.

To decide if an ARM is good for you, you need to look at your main goals. Do you want to have a lower monthly payment for a few years, with a plan to be able to potentially pay more down the line? This could be a good choice for you if you’re getting established in your career. Additionally, if you know you want to sell in a few years, an ARM may be right for you.

What is an advantage of an adjustable-rate mortgage?

“An ARM is a good fit for disciplined borrowers who have a plan in place to refinance or move within that initial seven or 10-year term,” says Shoemaker. “Perhaps it’s a young couple who is buying their first home together, but plan to buy a bigger home in the next few years. Maybe it’s someone whose career drives a lot of relocation as they climb the corporate ladder.”

Keep in mind, the initial lower interest rate will change after the introductory period dependent on the index rate your loan is tied to. ARMs have the initial interest rate that tends to be lower than other mortgage options. Then, after that introductory period where your rate stays the same, it enters the adjustment period. Here, it can continue to rise until it hits the rate cap.

What is an adjustable mortgage rate cap?

These protect borrowers to some degree by setting limits on how often, and how much, your lender can raise your mortgage interest rate. You’ll want to make sure that you understand how much the lender can raise your rate during a single adjustment period, how much it can change throughout all the adjustment periods, and if you have a payment limit that says how high your monthly mortgage payment can get. There are usually caps that stop your payments from going lower than a certain point should rates fall.

What is an adjustable-rate mortgage index? 

According to Investopedia, an adjustable-rate mortgage index is the “benchmark interest rate to which an adjustable-rate mortgage is tied. An ARM’s interest rate consists of an index rate value plus a margin. The index underlying the ARM is variable, while the margin is constant.” Essentially, the index rate value and the margin both determine your interest rate.

Can you refinance an adjustable-rate mortgage?

Yes. You can even refinance your adjustable-rate mortgage into a fixed mortgage. According to U.S. News & World Report, “In the right scenario, you could secure an interest rate that’s about the same or even lower than what you’re currently paying.”

How do I pick a mortgage?

Before deciding on a mortgage, it’s important to look at all of your options. This might sound like you just need to decide what type of mortgage you want and qualify for, but you should also look at a variety of different lenders, too. Each lender will have their own terms, fine print, and fees.

When you narrow down your options, you can also utilize a mortgage loan comparison calculator, which is one of the tools online that you can use to decide what mortgage loan to choose.

What resources or options do potential buyers have if they are finding mortgage rates or house prices too high?

With home prices in Austin increasing over recent years, home buyers searching for Austin homes are looking for more ways to increase their purchasing power. The experts we spoke to have a few creative options you might not have considered before.

These home financing options include:

Personal loans – According to Mike McClung of Integrity Cash Home Buyers, “personal loans are an excellent out-of-the-box way of financing your home. Personal loans are short term which means fewer interest payments, and you do not have to put up your house as collateral to the bank.” Experian notes that this option could be good for qualified buyers who are buying a tiny home, mobile home, or something similar with a lower cost because the maximum amount tends to be lower. This would be an alternative that would be likely to have a lower interest rate.

Seller financing – McClung says that seller financing is one alternative to a mortgage. “Some sellers give buyers the option of paying them in monthly installments. So, instead of owing the bank, you owe the seller directly.”

One benefit of this is that the process tends to be faster because buyers don’t go through the traditional loan application process. Your interest rate may be higher this way, but if you don’t qualify for a traditional mortgage, this is an option you might want to consider.

Renting out your home – If you’re having trouble with your mortgage payments, McClung says renting your house is an option. “Homes are assets, and subletting a portion of them can become a good source of passive income. You can use your rental income to pay out chunks of your mortgage.” This could be an option to help lower how much you personally have to contribute to your monthly mortgage payment.

Home equity line of credit (HELOC) – Martin Carreon, broker and owner of Soco Wine Country Properties, says “a home equity line of credit is one of the simplest yet best creative refinancing options in this current hot market. You don’t pay down the initial mortgage when using a home equity line of credit. This option lets you convert a portion of your homeownership into cash.

“Instead,” says Carreon, “you borrow up to 80% of the home’s worth (less the mortgage balance) against the value of your house. HELOCs normally have a draw duration that lasts ten years or less and a repayment period that is frequently no longer than fifteen years. The interest on a HELOC is tax deductible, but only up to $100,000, similar to a cash-out refinance.”

Buying points – Shaun Martin, owner and CEO of Denver Home Buyer, says that an option for homebuyers worried about rising interest rates is to buy points. “Buying points allows you to “prepay” some interest upfront in exchange for a lower rate over the life of your loan. This could save you money in the long run, but keep in mind that it will require more cash upfront,” says Martin.

Cash-out refinance – Alex Williams, Certified Financial Planner and CFO of FindThisBest, says that “a cash-out refinance is the best option in the current housing market, where house prices are too high and interest rates are rising. If you’re looking to buy another home, it’s best to cash out on the equity you’ve built on your current home and use it to secure a lower mortgage on your next purchase.”

Cash buyer programs – Many companies, like Homeward, allow you to make a cash offer. In competitive markets, some offers are stronger, like all-cash offers, which are 3x more likely to beat financed offers. This option works best for current homeowners who are looking to move because they can buy before they sell and pay a convenience fee of 1.4%. This can help with rising prices and rates because you can move quickly.

We’re seeing Austin’s housing market shift more toward a buyer’s market each day. In order to be able to act quickly on a home you are interested in, knowing your financing options and working with an experienced agent will give you a competitive edge.

Disclaimer: This information does not constitute loan advice. Reach out to a mortgage professional for advice about your unique situation. 

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