Which Mortgage is Right for You?
There are a number of different types of home loans available to you, and it can pay to familiarize yourself with them. Luckily, we're here to help you choose the best type of home loan for your needs.
Mortgage Rate Options
Fixed Rate
The traditional fixed-rate mortgage is the most common type of loan program, where monthly principal and interest payments never change during the life of the loan. Fixed-rate mortgages are available in terms ranging from 10 to 30 years and, in most cases, can be paid off at any time without penalty. This type of mortgage is structured, or “amortized,”so that it will be completely paid off by the end of the loan term.
Even though you have a fixed-rate mortgage, your monthly payment may vary if you have an "impound account." In addition to the monthly "principal + interest" and any mortgage insurance premium (an amount charged to homebuyers who put less than 20% cash down when purchasing their home), some lenders collect additional money each month for the prorated monthly cost of property taxes and homeowners insurance.
The extra money is put in an impound account by the lender, who uses it to pay the borrower's property taxes and homeowners insurance premium when they are due. If either the property tax or the insurance happens to change, the borrower's monthly payment will be adjusted accordingly. However, the overall payments in a fixed-rate mortgage remain very stable and predictable.
When the time comes for the ARM to adjust, the margin will be added to the index and typically rounded to the nearest 1/8 of one percent to arrive at the new interest rate. That rate will then be fixed for the next adjustment period. This adjustment can occur every year, but there are factors limiting how much the rates can adjust. These factors are called "caps". Suppose you had a "3/1 ARM" with an initial cap of 2%, a lifetime cap of 6%, and an initial interest rate of 6.25%. The highest rate you could have in the fourth year would be 8.25%, and the highest rate you could have during the life of the loan would be 12.25%.
Adjustable ARM
Adjustable Rate Mortgages (ARMs) are loans whose interest rate can vary during the loan's term. These loans usually have a fixed interest rate for an initial period of time and then can adjust based on current market conditions. The initial rate on an ARM is lower than on a fixed-rate mortgage, which allows you to afford and hence purchase a more expensive home. Adjustable-rate mortgages are usually amortized over a period of 30 years, with the initial rate being fixed for anywhere from 1 month to 10 years. All ARM loans have a "margin" plus an "index." Margins on loans typically range from 1.75% to 3.5% depending on the index and the amount financed in relation to the property value. The index is the financial instrument that the ARM loan is tied to, such as a 1-Year Treasury Security, LIBOR (London Interbank Offered Rate), Prime, 6-Month Certificate of Deposit (CD), and the 11th District Cost of Funds (COFI).
Interest Only
A mortgage is called “interest only” when its monthly payment does not include the repayment of principal for a certain period of time. Interest-only loans are offered on fixed-rate or adjustable-rate mortgages as well as on option ARMs. At the end of the interest-only period, the loan becomes fully amortized, thus resulting in greatly increased monthly payments. The new payment will be larger than it would have been if it had been fully amortizing from the beginning. The longer the interest-only period, the larger the new payment will be when the interest-only period ends.
You won't build equity during the interest-only term, but it could help you close on the home you want instead of settling for the home you can afford.
Since you'll be qualified based on the interest-only payment and will likely refinance before the interest-only term expires anyway, it could be a way to effectively lease your dream home now and invest the principal portion of your payment elsewhere while realizing the tax advantages and appreciation that accompany homeownership.
As an example, if you borrow $250,000 at 6 percent, using a 30-year fixed-rate mortgage, your monthly payment would be $1,499. On the other hand, if you borrowed $250,000 at 6 percent, using a 30-year mortgage with a 5-year interest-only payment plan, your monthly payment initially would be $1,250. This saves you $249 per month or $2,987 a year. However, when you reach year six, your monthly payments will jump to $1,611, or $361 more per month. Hopefully, your income will have jumped accordingly to support the higher payments, or you will have refinanced your loan by that time.
Mortgages with interest-only payment options may save you money in the short run, but they actually cost more over the 30-year term of the loan. However, most borrowers repay their mortgages well before the end of the full 30-year loan term.
Borrowers with sporadic incomes can benefit from interest-only mortgages. This is particularly the case if the mortgage is one that permits the borrower to pay more than interest-only. In this case, the borrower can pay interest-only during lean times and use bonuses or income spurts to pay down the principal.
When interest rates are high, borrowers can use a graduated payment mortgage to increase their chances of qualifying for the loan because the initial payment is less. The downside of opting for a smaller initial payment is that the interest owed increases, and the payment shortfall from the initial years of the loan is then added on to the loan, potentially leading to a situation called "negative amortization." Negative amortization occurs when the loan payment for any period is less than the interest charged over that period, resulting in an increase in the outstanding balance of the loan.
Graduated Payments
A graduated payment mortgage is a loan where the payment increases each year for a predetermined amount of time (such as 5 or 10 years), then becomes fixed for the remaining duration of the loan.
Loan Program Options
USDA Loan Thumbnail
USDA loans are low-interest mortgages with zero down payments designed for low-income Americans who don't have good enough credit to qualify for traditional mortgages. You must use a USDA loan to buy a home in a designated area that covers several rural and suburban locations.
Conventional loans offer several advantages. First, they often have more flexible terms and lower interest rates than government-backed loans. Additionally, conventional loans also allow for higher loan amounts, making them suitable for financing higher-priced homes.
It is possible to obtain a conventional mortgage loan with a down payment as low as 3%. While conventional loans traditionally require a larger down payment, some borrowers may qualify to purchase a home with a 3%-5% down payment. Keep in mind that a lower down payment may result in additional costs, such as private mortgage insurance (PMI).
To qualify for a conventional loan, you generally need a good credit score (usually above 620), a stable employment history, and a manageable debt-to-income ratio. Other factors, such as your income, assets, and the property's appraisal value, will also be considered. Specific requirements may vary, so it's essential to consult with a mortgage professional to determine your eligibility.
Conventional loans can be an excellent choice for many homebuyers. They often offer competitive interest rates, term flexibility, and the ability to finance various property types. However, whether a conventional loan is the best option depends on your financial situation, credit history, and preferences. It's always a good idea to explore multiple loan options and consult a mortgage professional to determine the best fit for your needs.
The timing for refinancing an FHA loan into a conventional loan depends on several factors. In most cases, you can refinance an FHA loan into a conventional loan once you have built enough equity in your home. Typically, this means reaching an 80% loan-to-value (LTV) ratio. However, specific requirements may vary, so it's important to discuss your options with a mortgage professional who can guide you through the process.
There are several options available to help cover closing costs with your conventional loan:
- Ask the seller for "seller concessions" to help pay your closing costs. You can negotiate this into your contract when buying the home. Let your real estate agent and mortgage professional know if you plan to ask for seller concessions. Keep in mind that feasibility may vary depending on the real estate market conditions.
- Consider paying a higher mortgage interest rate in exchange for the lender's assistance covering your closing costs. This is commonly known as "buying up" your interest rate.
- Some conventional home loan programs allow gift money from family members, employers, or close friends to help with closing costs. Let your mortgage professional know if you plan to use gift money for this purpose.
- Explore grants and forgivable loans through down-payment assistance programs. These programs are typically managed at the county or state level, and their eligibility requirements vary. Consult your mortgage professional to see if any applicable down payment assistance programs are available to you.
It is possible to obtain a conventional loan if you owe taxes, but it depends on several factors. First, it's important to understand the difference between owing taxes and having a tax lien. Owing taxes means you owe money to the IRS and/or a state, while a tax lien occurs when your unpaid taxes result in collection actions. Having an IRS lien on your income or assets can significantly decrease your chances of being approved for a conventional mortgage.
Communicate openly with your mortgage professional to guide you through the loan application process and help you explore potential solutions or alternatives.
Higher Loan Limits: Conventional loans generally offer higher loan limits compared to FHA loans. This can be beneficial if you are looking to finance a more expensive property or live in a high-cost area, as it allows you to borrow a larger amount.
No Upfront Mortgage Insurance: Unlike FHA loans, Conventional loans do not require upfront mortgage insurance premiums. This means you can save on the upfront costs associated with the loan and potentially lower your overall loan amount.
Flexible Mortgage Insurance Options: With a Conventional loan, once you reach a loan-to-value (LTV) ratio of 80% or less, you have the option to cancel private mortgage insurance (PMI) or request its removal. This can result in significant savings over time compared to FHA loans, which typically require mortgage insurance for the entire loan term.
More Lenient Property Standards: Conventional loans generally have more flexibility when it comes to property conditions and appraisal requirements. FHA loans often have stricter property standards, which could limit your options when purchasing a home that needs repairs or renovations.
It's important to note that both loan types have their own advantages and considerations, and the right choice depends on your specific financial situation and goals. Consulting with a mortgage professional can help you evaluate the options and determine the best fit for your needs.
Conventional Loans
A conventional loan is a type of loan that doesn't have government backing or insurance, unlike FHA, VA, and USDA loans, which are insured by the government. Conventional mortgage loans, whether conforming or non-conforming, usually require a slightly larger down payment than some government loans. However, conventional loans offer more flexibility and fewer restrictions for borrowers, especially those borrowers with good credit and steady income.
FHA Home Loans
FHA home loans are mortgage loans that are insured against default by the Federal Housing Administration (FHA). FHA loans are available for single-family and multifamily homes. These home loans allow banks to continuously issue loans without much risk or capital requirements. The FHA doesn't issue loans or set interest rates; it just guarantees against default.
FHA loans allow individuals who may not qualify for a conventional mortgage to obtain a loan, especially first-time home buyers. These loans offer low minimum down payments, reasonable credit expectations, and flexible income requirements.
In 1934, the Federal Housing Administration (FHA) was established to improve housing standards and to provide an adequate home financing system with mortgage insurance. Now families that may have otherwise been excluded from the housing market could finally buy their dream home.
FHA does not make home loans; it insures a loan; should a homebuyer default, the lender is paid from the insurance fund.
- Buy a house with as little as 3.5% down.
- Ideal for the first-time homebuyers unable to make larger down payments.
- The right mortgage solution for those who may not qualify for a conventional loan.
- Down payment assistance programs can be added to an FHA loan for additional down payment and/or closing cost savings.
Your loan approval depends 100% on the documentation that you provide at the time of application. You will need to give accurate information on:
Employment
Complete income tax returns for the past 2 years
W-2 & 1099 Statements for the past 2 years
Paycheck Stubs for the past 2-months
Self-Employed Income Tax Returns and YTD Profit & Loss Statements for the past 3 years for self-employed borrowers
Savings
Complete bank statements for all accounts for the past 3 months
Recent account statements for retirement, 401(k), mutual funds, money market, stocks, etc.
Credit
Recent bills & statements indicating account numbers and minimum payments
Landlord's name, address, telephone number, or 12- months cancelled rent checks
Recent utility bills to supplement thin credit
Bankruptcy & Discharge Papers if applicable
12-months cancelled checks written by someone you co-signed for to get a mortgage, car, or credit card, this indicates that you are not the one making the payments.
Personal
Drivers License
Social Security Card
Any Divorce, Palimony or Alimony or Child Support papers
Green Card or Work Permit if applicable
Any homeownership papers
Refinancing or Own Rental Property
Note & Deed from any Current Loan
Property Tax Bill
Hazard Homeowners Insurance Policy
A Payment Coupon for Current Mortgage
Rental Agreements for a Multi-Unit Property
The main difference between a FHA Loan and a Conventional Home Loan is that a FHA loan requires a lower down payment, and the credit qualifying criteria for a borrower is not as strict. This allows those without a credit history, or with minor credit problems to buy a home. FHA requires a reasonable explanation of any derogatory items, but will use common sense credit underwriting. Some borrowers, with extenuating circumstances surrounding bankruptcy discharged 3-years ago, can work around past credit problems. However, conventional financing relies heavily upon credit scoring, a rating given by a credit bureau such as Experian, Trans-Union or Equifax. If your score is below the minimum standard, you may not qualify.
Your monthly costs should not exceed 29% of your gross monthly income for a FHA Loan. Total housing costs often lumped together are referred to as PITI.
P = Principal
I = Interest
T = Taxes
I = Insurance
Examples:
Monthly Income x .29 = Maximum PITI
$3,000 x .29 = $870 Maximum PITI
Your total monthly costs, or debt to income (DTI) adding PITI and long-term debt like car loans or credit cards, should not exceed 41% of your gross monthly income.
Monthly Income x .41 = Maximum Total Monthly Costs
$3,000 x .41 = $1230
$1,230 total - $870 PITI = $360 Allowed for Monthly Long Term Debt
FHA loan ratios are more lenient than a typical conventional loan.
Yes, generally a bankruptcy won't preclude a borrower from obtaining an FHA loan. Ideally, a borrower should have re-established their credit with a minimum of two credit accounts, such as a car loan or credit card. Then wait two years after the discharge of a Chapter 7 bankruptcy, or have a minimum of one year of repayment for a Chapter 13 (the borrower must seek the permission of the courts). Also, the borrower should not have any credit issues like late payments, collections, or credit charge-offs since the bankruptcy. Special exceptions can be made if a borrower has suffered through extenuating circumstances like surviving a serious medical condition and had to declare bankruptcy because the high medical bills couldn't be paid.
The Veteran Administration's loan originated in 1944 through the Servicemen's Readjustment Act, also known as the GI Bill. It was signed into law by President Franklin D. Roosevelt and was designed to provide veterans with a federally guaranteed home loan with no down payment. VA loans are made by private lenders like banks, savings & loans, and mortgage companies to eligible veterans for homes to live in. The lender is protected against loss if the loan defaults. Depending on the program option, the loan may or may not default.
Wartime/Conflict Veterans
- Veterans who were NOT dishonorably discharged and served at least 90 days
- World War II – September 16, 1940, to July 25, 1947
- Korean Conflict – June 27, 1950, to January 31, 1955
- Vietnam Era – August 5, 1964, to May 7, 1975
- Persian Gulf War - Check with the Veterans Administration Office
- Afghanistan & Iraq – Check with the Veterans Administration Office
- Veterans Administration website www.va.gov
Peacetime Service
At least 181 days of continuous active duty with no dishonorable discharge. If you were discharged earlier due to a service-related disability, you should contact your regional VA office for eligibility verification.
- July 26, 1947, to June 26, 1950
- February 1, 1955, to August 4, 1964, or May 8, 1975, to September 7, 1980 (Enlisted), or to October 16, 1981 (Officer)
- Enlisted veterans whose service began after September 7, 1980, or officers whose service began after October 16, 1981, must have completed 24 months of continuous active duty and been honorably discharged
Reserves and National Guard
- Certain U.S. citizens who served in the armed forces of a government allied with the United States during World War II.
- Surviving spouse of an eligible veteran who died as a result of service, and has not remarried.
- The spouse of an Armed Forces member who served active duty and was listed as a POW or MIA for more than 90 days.
A VA home loan must be used to finance your personal residence within the United States and its territories. You have choices for the type of home you purchase:
- Existing Single-Family Home
- Townhouse or Condominium in a VA-Approved Project
- New Construction Residence
- Manufactured Home or Lot
- Home Refinances and Certain Types of Home Improvements
- 100% Financing & No Down Payment Loans
- No Private Mortgage (PMI)
- No Penalties for Prepaying the Loan
- Competitive Interest Rates
- Qualification is Easier than a Conventional Loan
- Sellers Pay Some of the Closing Costs
- Can be combined with additional down payment assistance to reduce closing costs
You can apply for a VA Loan with any mortgage lender that participates in the program. In addition to the application requirements from your lender, you will need the following at application time:
- Certificate of Eligibility from the Veterans Administration by submitting a completed VA Form 26-1880.
- Proof of Military Service from a VA Eligibility Center
Yes, your eligibility is reusable depending on the circumstance. If you have paid-off your prior VA Loan, and disposed of the property, you can have your eligibility restored again. Also, on a 1-time basis, you may have your eligibility restored if your prior VA Loan has been paid-off, but you still own the property. Either way, the Veteran must send the Veterans Administration a completed VA Form 16-1880 to the VA Eligibility Center. To prevent delays in processing, it's advisable to include evidence that the prior loan has been fully paid, and if applicable, the property was disposed of. A paid-in-full statement from the former lender or a copy of the HUD-1 settlement statement must be submitted.
- VA Loans made prior to March 1, 1988 can be assumed with no qualifying of the new buyer. If the buyer defaults the property the Veteran homeowner may be liable for the funds.
- Some sellers are hesitant to work with someone obtaining a VA Loan because it takes longer than a conventional loan to process.
- Sellers are often asked to pay a portion of closing costs and therefore less likely to negotiate the sales price of the home.
VA Loans
The VA Loan provides veterans with a federally guaranteed home loan that requires no down payment. This program was designed to provide housing and assistance for veterans and their families.
The Veterans Administration provides insurance to lenders in the case that you default on a loan. Because the mortgage is guaranteed, lenders will offer a lower interest rate and terms than a conventional home loan. VA home loans are available in all 50 states. A VA loan may also have reduced closing costs and no prepayment penalties.
Additionally, there are services that may be offered to veterans in danger of defaulting on their loans. VA home loans are available to military personnel that have either served 181 days during peacetime, 90 days during war, or a spouse of a serviceman either killed or missing in action.
Jumbo Loans
A jumbo loan is a mortgage used to finance properties that are too expensive for a conventional conforming loan. The maximum amount for a conforming loan is $766,550 in most counties, as determined by the Federal Housing Finance Agency (FHFA). Homes that exceed the local conforming loan limit require a jumbo loan.
Also called non-conforming conventional mortgages, jumbo loans are considered riskier for lenders because these loans can't be guaranteed by Fannie and Freddie, meaning the lender is not protected from losses if a borrower defaults. Jumbo loans are typically available with either a fixed interest rate or an adjustable rate, and they come with a variety of terms.
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