Mortgage Basics

Understand These Mortgage Basics to Make You a Savvy Homeowner and Real Estate Investor

There are many different types of mortgages out there. As savvy homeowner or real estate investor, you need to understand mortgage basics. The more you understand how mortgage works and the types of mortgage available, you’ll have more options in financing your purchase.

If you’ve been alive the last couple of years, you’ve probably heard a lot about Fannie Mae and Freddie Mac on the news in relation to the real estate bubble burst in 2008.

Who are Fannie Mae and Freddie Mac?

Fannie and Freddie are not real person. Just as Uncle Sam is not real.

Fannie Mae is nickname for Federal National Mortgage Association and Freddie Mac is nickname for Federal Home Loan Mortgage Corporation. They are both government agencies that purchase home loans from banks.

Watch this video from Wall Street Survivor, which will explain the mortgage basics in a nutshell.

Here…I’m going to discuss the most simple and common types of mortgages or home loans available to finance a home or investment property purchase. Just so you can get some ideas to start with. There are many more different types of mortgages and creative strategies to fund a home or investment property purchase.

You'll find them under Hawaii Hard Money Lenders and Hawaii Private Money Lenders.

There are generally 2 types of homes loans or mortgages: CONVENTIONAL and NON-CONVENTIONAL

Ok…here’s the true story.

After a bank closes on your mortgage, they’ll turn around and sell your mortgage note to Fannie Mae or Freddie Mac. That is the reason why banks have to follow the guidelines from Fannie and Freddie, such as minimum 20% down payment, debt to income ratio of less than 43%, etc.

That's "conventional mortgage" in a nutshell. Plain vanilla loan.

NON-CONVENTIONAL LOANS

Low Down Payment Loans

FHA Loans - 3.5% down payment for owner-occupant

Fannie Mae HomePath Home Loan - 3% down payment for owner-occupant, 10% for investor

100% Financing or 0% Down Payment Loans

USDA Loan

VA Loan

With any low- or no-down-payment home loans, you, the buyer, has to be aware of Private Mortgage Insurance.

Fixed vs ARM You’ve seen banks everywhere advertising their “fixed” and “ARM” home loans.

Exactly, what are they?

Fixed rate mortgages is when the rate of the mortgage is “fixed”. With a fixed rate mortgage, the interest rate you pay is the same every year as long as you have the mortgage.

The ARM or Adjustable Rate Mortgage, on the other hand, gives you flexibility in the interest rate. Usually you have the option for the mortgage rate to be fixed for a certain number of years initially, after that the rate will follow the market rate, which may be higher or lower than your initial fixed rate.

An adjustable rate mortgage is also known as a "variable-rate mortgage" or a "floating-rate mortgage".

Related article: What is Annual Percentage Rate (APR)

Prequalifications vs Preapprovals

With a prequalification, your assessment to purchase a mortgage or home loan is based solely on a verbal conversation. There’s no credit check, which can lead to a less accurate assessment of how much home you can afford.

On the other hand, when you get a documented preapproval, you’ll know exactly what you can afford and how much since a credit check is part of the process. You can then shop for a home with a realistic budget in mind.

Amortization vs Simple Interest

Understanding how amortization works for the bank and knowing the difference between amortization and simple can save you loads of money in interest payment. And you’ll also understand why you shouldn’t refinance your mortgage.

Amortization is the process of paying off your mortgage with regular payments over time. You pay the same amount every month for 15 or 30 years, depending on your loan terms. In the beginning of your loan, you’re paying mostly interest, and very little of your payment goes to the principal. As the time goes by, you pay less and less interest and more toward principal.

If you only plan to be in a home short term, it is important to remember that you will owe a majority of the principal when you go to sell since you pay more interest in the beginning.

This is the exact reason why you should NOT keep refinancing your home loans. Each time you refinance, you reset the clock to the beginning. The 30 year starts again. Then you end up paying mortgage interest forever, and never get to pay down your principal. People always think refinancing to a lower rate mortgage will save them money. It is not true.

If you want to pay off your mortgage fast, make additional or larger payments each month helps save money in the long term. Specify that you want the additional payments to go towards your principal balance. Be sure there is no prepayment penalties by paying off your mortgage sooner. The prepayment penalty can eat up all your interest savings.

Related article: Pay Off Your Mortgage in 7 Years

Another way to pay off you mortgage quickly is with a home equity line of credit or HELOC

Well…this is a good time to introduce the concept of simple interest. I love simple interest as a borrower.

Simple interest is how credit card companies figure out how much you owe. Bank uses this same concept to calculate your interest in your savings account, and HELOC.

Simple interest is calculated on a daily basis. If you pull one of your credit card statement out, and look at the back, you’ll see different rates that your credit card company charges you. One of the rate is a daily rate, which maybe 0.0004%. Your interest on your credit card balance or HELOC balance is calculated on a daily basis. The lower your daily balance the lower your rate, which gives you the incentives to pay down the balance as soon as possible.

With a HELOC, you save on loan interest, pay off your principal sooner and you have a line of credit that is available also as your emergency fund.

Related article: Home Equity Line of Credit

Zero Down VA Loan

Purchase Your Next Home with Zero Down Payment with a VA loan

If you are a US military veteran, or if you are currently serving our country and have been on active duty for a minimum of 90 days, you could qualify for a VA Loan. With the special benefits, a VA Loan provides almost the best choices of financing available to eligible borrowers.

The Veterans Administration does not actually lend money. They work with mortgage lenders to guarantee the homes loans in the event that the VA homeowner forecloses, the VA will reimburse the mortgage lender all or portion of the mortgage owned.
This guarantee enables lenders to provide loans to borrowers who may not qualify for other conventional loans.

VA LOANS ADVANTAGES

The number one reasons to finance your homes with a VA loan is “zero down payment”. With a VA loan, you do not need to come up with a down payment. You can finance up to 100% of your home purchase with a VA loan. That means you save many years to save up money as down payment.

VA loans generally have lower interest rates than most conventional loans, which means affordable monthly payments.
With a conventional mortgage, a borrower who does not put at least 20% down payment, is required to pay VA loans do not require to pay private mortgage insurance, or PMI. So with a VA loan, this translates into monthly savings of $200 - $400 a month.

With a VA loan, eligible veterans can easily save up to $2,000 in closing cost as many closing fees are waived.

VA LOAN LIMITS

The maximum VA loan amount (with no down payment) is determined by average home prices in each county. In Hawaii, the maximum amount with no down payment is $721,050 for Oahu, $713,000 for Kauai, $657,800 for Maui, Lanai and Molokai, and $625,500 for Big Island.

You may also qualify for a VA loan of up to $1.5 million if you are willing to make a small down payment.

ELIGIBILITY

If you enlisted or entered service before September 7th, 1980 you may be eligible for the VA Loan program if you served at least 90 days in wartime or 181 days in peacetime.

If you enlisted after Septem 7th, 1980 or entered service as an officer after October 16th 1981, you would have to serve at least 24 consecutive months (or the full period called to active duty not less than 90 days in peacetime or 181 days in wartime) to qualify for a VA loan.

Reservists in Army National Guard, Army Reserve, Air National Guard, Coast Guard Reserve, Navy Reserve, Marine Corps Reserve and Air Force Reserve are also eligible. At least 6 years of service, can be non-consecutive, are required.

OCCUPANCY REQUIREMENTS

Unlike conventional loans, VA loans are only for primary residences. The Veterans should be prepared to move into the new home within 60 days after the loan closing.

Download the VA Loan Guide below for details: