In this article we will discuss the different varieties of mortgages. They can be broken down into two main categories. The most common is the conventional loan which is not backed and insured by the government. It is simply an agreement between the lender and the lendee(you).
The second type is government backed loans such as those issued by the Federal Housing Commission, Department of Veteran Affairs, or Department of Agriculture. We will explain both types of loan products below and further dive into different varieties of these products.
If you are looking for a home and don’t know what type of product you could best utilize given your financial situation this post will help shed light on what is out there and the variables that need to be taken into consideration. When it comes down to talking to a mortgage professional you will be equipped with the fundamental knowledge to make an educated decision regarding financing your home simply by reading this short blog post. It’s in your best interest to have this basic knowledge under your belt. We’ll start with the general variables involved in all mortgages.
Some variables to consider with home loans or mortgages is the amount of money to put down, loan term, whether or not the rate is adjustable or fixed, and the LTV or “loan to value” ratio, the interest rate or APR, and amortization schedule. We’ll address these briefly one at a time and what could affect each one respectively.
The down payment really depends on what you can afford first and foremost. Only you really know this. How much cash do you have to spend today? Other factors that affect downpayment is the purchase price and the required percentage needed to be put down as decided by the bank, which should follow the guidelines set forth by the government. Naturally, the more you put down the smaller your monthly payment will be as well as the potential for your APR or “annual percentage rate” to be lower.
The loan term, or duration of the loan depends on what you would like your monthly payment to be as well as your interest rate. The difference between paying off a $100,000 loan in 15 years and paying off the same amount in 30 years means your note will be significantly higher for the 15 year note, but you’ll pay significantly more in interest on the 30 year note due to the passing of more time.
A benefit with the 30 year note is that you’ll have more room for savings and other expenditures than with the 15 year note due to the higher monthly payment, but you’ll pay for that wiggle room that the 30 year provides via interest for an additional 15 years.
A benefit of the 15 year note is that it simply gets paid off much quicker. If you have stable income this route could make more sense, but if you lose your job or your income changes you could be in a financial bind paying the much higher monthly loan payment.
Adjustable Rate Mortgages or ARMS are loans that have APRs that are adjustable given certain economical factors. It periodically will be adjusted to reflect the rate of the particular index that reflects the cost on the lender to execute the loan. To put in layman’s terms, if a bank borrows money at a rate based on an index, then turns around and loans that money to you, the bank will increase the price of your loan by whatever their price has gone up for carrying the loan.
The benefit of ARMs is that the initial rate of the loan is sometimes lower than a fixed rate loan, but could potentially go up as the duration of the loan goes on. In the end you usually end up paying more, but every loan is different and this factor depends on the performance of the index that the loan is mirroring.
Next up we get to the loan to value ratio. The “value” part of this equation depends on the appraised value of the subject property. This is done via a bank appraisal during the “under contract” period when buying a new house. This loan amount is, well, the loan amount. If you buy a house for $100,000 and put the required 20% down then the loan will be for $80,000, which is an 80% LTV. Lenders require that borrowers pay for mortgage insurance when the LTV is greater than 80 percent, so paying at least 20% down has additional benefits aside from just lower APR and lower monthly payments.
Next, we get to the interest rate. This rate depends on all the above factors on top of your personal qualifications such as income and credit rating. The better your qualifications are coupled with how much you can put down and your loan term determine your interest rate. Currently rates are relatively low, which is good for potential home owners looking to finance a home.
Finally, the last factor to consider and be aware of that we will go over here is the amortization schedule. Amortization means the spreading of payments over a determined period of time to fully, or not fully, satisfy the loan. A fully amortizing loan means the periodic payments will result in the loan being paid in full by the end of the loan term. Some loans are partially amortizing, meaning at the end of the loan a balloon payment (lump sum) will become due. This is something to be aware of, but usually conforming conventional loans are fully amortizing.
Below we will now break down the two main categories of loans. Conventional and Government backed loans. We’ll start with the most common product used to buy single family homes today, the conventional mortgage.
The most common type of mortgage is conveniently called a “conventional” or “traditional” mortgage. This product is used for approximately 70% of all home sales. This type of loan gives borrowers a variety of options, from 30-year fixed rates to short-term ARMs. We’ll explain these different varieties below.
Conventional mortgages can be further broken down into “conforming” or “non-conforming” loans. This term is used because conforming loans follow the guidelines put in place by Fannie Mae and Freddie Mac regarding underwriting and are limited to $453,100 as of 2018. For the sake of this article we will focus on conforming loans only, as they are by far the most common. We also have a short post on our website that dives into what Fannie and Freddie are and the implications of these agencies on the housing market. You can visit that post here.
Conventional loans will require a minimum down payment of anywhere from 10% percent to 20% and typically a credit score of more than 700. These requirements can be quite tough for a lot of people, but unfortunately this is the nature of these loans. Down payment and credit score requirements do depend on individual lenders and can vary, but they typically will fall in this range due to the nature of the product and the guidelines put in place by Fannie and Freddie.
The requirements for a traditional mortgage tend to be exceptionally stricter than those of government backed loans due to the 2008 market crash. Back then the banks were approving almost everyone for any size loan. If you had a pulse you could buy a home. Sounds nice, but there are serious repercussions to this. The majority of the country were upside-down on their loans. People couldn’t truthfully afford their homes and prices were artificially going up due to the ease of financing, which created a bubble. When that bubble burst everyone lost their homes because the values plummeted, but the loans they owed on still existed. These loans are commonly referred to today as “liar loans”. Today the government regulations have tightened up under the Dodd Frank Act and various other efforts to prevent this scenario from repeating by ensuring people can properly afford their homes before qualifying for a loan. Basically, banks are kept in tighter check by the government.
If you have good credit coupled with adequate savings for a large down payment the traditional loan may be the best option for you. Not to fear if this isn’t your case. If you qualify for one of the government backed loans discussed below the qualifications are much more lenient. The government favors home ownership so they incentivize it in various ways.
FHA/VA; Government Mortgage Loans:
We’ll begin this part of the discussion with the more popular of the two options, FHA(Federal Housing Administration) loans. FHA loans are insured by the FHA and are geared toward first time homebuyers and middle to low income earners to obtain a home.
These loan products allow these folks to obtain a loan for a home purchase in various ways. The first way is by approving the individual for the loan with a credit score much lower than what is required for a conventional mortgage through more traditional lending institution. Typically if you have a 580 or higher you can be approved for an FHA loan compared to conventional mortgages which are looking for credit scores around the 700 mark with a minimum around 620.
The second way is by allowing individuals to purchase the home with exceptionally low down payments. FHA loans only require about 3.5% down at the time of purchase compared to conventional mortgages which require you to put down upwards of 20%.
The FHA can also play with these numbers in relation to each other. For instance, if your credit is lower than the typical 580 minimum for FHA loan, but you can put upwards of 10% down, they may still approve your loan. Remember, the federal government likes home ownership.
Typically to be approved for this loan your total debt (mortgage plus all additional debt) must be less than 43% of your gross monthly income. You also must purchase mortgage insurance for FHA loans, which is typically about 1.75% of the policy and is due upfront. In 2018, the maximum loan amount is $294,515 for single family homes in low cost areas and $679,650 in high cost areas. You can apply and get more detailed and specific information from FHA mortgage lenders or brokers or on the HUD website.
VA loans are loans backed by the Department of Veteran Affairs and look slightly different than FHA loans, but are looking for the same desired outcome for it’s participants, which is obtainable home ownership. To be a participant in a VA loan you must be either:
- Active-duty personnel
- Reserve members
- National Guard members
- Some surviving spouses
For a full list of eligibility please visit the VA’s government website here: Eligibility
To get a VA loan, in addition to being one of the listed above, you must hold a Certificate of Eligibility or COE. You can request a COE through a VA approved lender or online here: VA’s COE Portal
With VA loans there are typically better benefits than even an FHA loan. There is often times zero downpayment required and they will provide a LTV of 100%! No private mortgage insurance is required as with FHA loans. VA rules limit the amount of closing costs you can be charged. VA will even help out veterans in default on their loan in certain instances after they are already in the home. Generally, the maximum loan amount is $417,000 but can be higher depending on where the subject property is located.
That’s mortgages in a nutshell. There are of course tons of scenarios and no two loans or people are the same. To go over every detail is not only impossible but goes beyond the scope of this blog. You know the major variables associated with mortgages and why these variables need to be analyzed and assessed when looking at different options. It all depends on your goals and financial situation. Hopefully these once obscure terms make more sense and when you are ready to sit down with a loan professional you can get into a loan product that best suits your needs.