An overview of primary mortgages: A guide for first-time homebuyers
June 15, 2023 • 5 min read
What is a primary mortgage?
A primary mortgage, as its name suggests, is a mortgage taken out on a borrower’s primary residence. But what defines a primary residence? The answer lies in the term "occupancy”, a crucial term l when learning about primary mortgages. Essentially, occupancy refers to how a property is used, determining the mortgage type a borrower receives.
Your primary residence is typically the home where you spend most of your time. This differentiates it from an investment property or a secondary residence.
If you own one home and live in it, it’s going to be classified as your primary residence. But if you live in more than one home, the IRS determines your primary residence by:
- Where you spend the most time
- Your legal address listed for tax returns, with the USPS, on your driver’s license and on your voter registration card
- The home that is near where you work, bank, family members, and/or recreational clubs.
Investment properties are real estate assets purchased primarily for earning returns through rental income, appreciation, or both. In contrast, a secondary residence, such as a vacation home, is not your primary dwelling but a property you occasionally live in 2.
How does the primary mortgage market work?
The primary mortgage market is the sphere where borrowers and lenders form an agreement for new mortgage loans. Here's a look at the key stakeholders in this market:
- Banks: They typically have a range of mortgage products and deal directly with consumers.
- Mortgage Brokers: They act as intermediaries between borrowers and lenders, helping borrowers find the best rates and terms.
- Mortgage Bankers: Unlike brokers, they lend their own capital to fund mortgages.
- Credit Unions: These are member-owned cooperatives that often offer favorable rates to their members.
Once a loan is originated in this market, it often finds its way into the secondary market. This process is critical because it frees up lenders' resources, enabling them to provide more loans3.
Two significant players in the secondary market are Fannie Mae and Freddie Mac, government-sponsored entities. They buy, bundle, and sell mortgages as mortgage-backed securities (MBS).
This act of securitizing mortgages not only ensures liquidity in the market but also encourages lenders to offer more loans, including those to riskier borrowers, as the risk is now spread across many investors 4.
Different types of primary mortgage loans
Understanding the array of primary mortgage loans available helps to identify the one most suited to your situation. Here's a closer look:
Fixed-Rate Mortgages: These offer a stable interest rate over the life of the loan, ideal for those seeking predictability 5.
Adjustable-Rate Mortgages (ARMs): These have fluctuating interest rates over time. They may suit individuals expecting income growth or planning to sell before a rate increase 6.
Federal Housing Administration (FHA) Loans: These are targeted toward borrowers with lower credit scores or minimal down payment. The FHA insures these loans, thus enabling lenders to offer them at competitive rates 7.
Veterans Administration (VA) Loans: Specifically designed for veterans and active-duty military personnel, they offer benefits like zero down payment and competitive rates 8.
Potential benefits of a primary mortgage
There are numerous potential advantages to working with locally-owned or private lenders when securing a primary mortgage loan. Some of these advantages are related to costs, while others are linked to flexibility and personalized service.
Lower closing costs: Locally-owned banks or private lenders often manage the credit analysis and underwriting process in-house. Compared to large banks with a centralized unit, they can typically offer lower fees due to less overhead9. Additionally, bypassing a mortgage broker can also eliminate associated fees. Opting for a locally-run bank for a primary mortgage can therefore help reduce closing costs.
Small down payments: While a standard down payment for a mortgage is often 20% of the purchase price, many primary lenders can offer lower down payments, even as low as 10% 9. For low-to-moderate income borrowers, an FHA loan can require as little as 3.5% down. However, be aware that a down payment of less than 20% usually triggers the need for private mortgage insurance (PMI), which can add to your monthly payments until 20% of the mortgage loan has been paid off 10.
Flexibility: Locally-owned banks often offer more flexibility, as borrowers are likely to have direct communication with the final decision-makers. This direct contact can be particularly beneficial if you have a unique financial situation. These lenders might also offer different mortgage options, such as a fixed-rate 15-year mortgage for borrowers looking to pay off the loan sooner. These mortgages often come with lower interest rates and less total interest charged over the lifetime of the loan11. Conversely, a 30-year mortgage could be more suitable for those seeking lower monthly payments, as these are spread out over a longer period.
The primary mortgage market is a fundamental pillar of the real estate industry. It plays a crucial role in facilitating homeownership, with a wide range of loan types designed to accommodate different borrower profiles. By understanding the inner workings of this market and the unique advantages it offers, first-time homebuyers are better equipped to navigate their journey towards homeownership confidently and effectively.
Ready to buy or upgrade your primary home?
The opinions expressed in the Blog are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security or investment product.
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