Comparison of Different Ways of Home Financing

October 17, 2022

Buying your first home is a big step and it puts a lot of financial pressure on your wallet. Because of this, it’s important to compare the different ways of financing a home purchase.

In today’s article, we’ll be comparing the most common ways of home financing and put their pros, but even more importantly – their cons under a spotlight.

A Conventional Mortgage

Getting a mortgage is the most common way of financing your home. It works by a bank or a credit union financing the property you’re purchasing, and you paying them off in small installments during a long time period.

You normally have to make a monthly mortgage payment that covers the principal portion of the loan, the bank’s interest rate, your taxes, and your insurance.

Just to clear it up, the principal portion of the loan is part of the money your bank paid for your home. The interest is the additional money you’re paying the bank for granting you a mortgage (this is, among other ways, how banks make money).

The tax is 1/12 of your yearly property tax, while the insurance money is there to cover the insurance your bank requires be applied to your home.

There are different types of mortgages. You can have a fixed-rate mortgage, where you pay an identical monthly payment every month. Adjustable-rate mortgage has a lower rate initially (for a pre-agreed time period), while the rate rises when that time period ends.

There are also long-term and short-term loans, the former having smaller monthly payments but greater interest, while the latter has the opposite.

While this is a safe way for buying a home, it has two major drawbacks.

Firstly – your home can lose value with time. Let’s say you buy a home for $100 000 and you plan to pay it off in 25 years. After 10 years, the value of your home could drop to $70 000, but the agreement won’t change – you’ll still have to pay off $100 000.

The other drawback is that you can lose your home if you make payments – your property is actually the collateral for the mortgage agreement.

Reverse Mortgage

A reverse mortgage is a home loan available for homeowners who are 62 or older. This type of mortgage essentially allows the homeowner to borrow money from a lender, while their home is used as collateral for the agreement.

Fees of all reverse mortgage agreements are different to standard mortgage. The homeowner only has to pay property tax and insurance, but they don’t have to pay the principle part of the loan and the interest right now.

The idea is that you get to live in your home for however long you’d like, but once you sell it or die, you (or your heirs) have to pay off the mortgage. This is usually done by selling the home.

Government-Issued Loans

In the USA, you might qualify for government-issued loans! Military veterans (regardless of the branch), for example, are offered loans, while you can also look into the Federal Housing Administration for loans.

Loans are also provided for first-time homebuyers, while refinancing loans are also available.

The government doesn’t necessarily provide the money (although in some cases it does), but it will certainly guarantee the loan.

Rent-To-Own

A rent-to-own agreement is usually seen as one of the last resorts. It means that you live in the home as a tenant, paying rent to your landlord, while you simultaneously build up savings so you could actually pay for the property.

This isn’t that popular for the most obvious reason – you have to pay rent for the home that you’ll be buying either way. However, it can be a viable option if you can guarantee that you’ll have enough money for a traditional mortgage in a few months/years.

Rent-to-own agreements are usually agreed for a specific time period.

Using Your Retirement Savings

Financial experts say that this should always be your last option, but you can legally borrow some money from your retirement fund. This money is usually taken to help you with the down payment.

The issue is, you have to return the money to the retirement fund within five years, otherwise you have to pay a 10% penalty. It’s a complex situation and if you don’t play your cards right, you could end up paying more money than you initially took out of the fund.

In most cases, you can borrow up to $10 000 without having to pay for a penalty if you don’t pay the money back on time. This amount is also small enough for you to be able to pay it back on time!

 

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