Guide to Basic Mortgage Options
Looking at your options for mortgages can be rather intimidating at times. There are many options that go along with home refinances and purchases. The three following categories are the three major factors that go into deciding on what mortgage product best fits you. Keep in mind that other factors like down payment, credit, and income all can effect what mortgage you get additionally. These three factors help explain what types of options are available.
Conforming vs Non-Conforming
This mortgage factor is determined by the type of underwriting that is used on the loan. Underwriting is the process that the bank uses to review your financial information to determine your credit-worthiness.
Conforming – Freddie Mac and Fannie Mae are two government-controlled corporations that put out underwriting guidelines. They put limitations on loan applications involving the loan size, debt-to-income ratio, loan-to-value, credit score, documentation, etc. Loans that “conform” to these guidelines are very liquid, meaning that the originating bank can easily sell the loan to investors on the secondary market.
Non-Conforming – These are loans that do not meet the standard government guidelines. They can include jumbo loans (loans over the size limit), high loan-to-value loans, and subprime loans. While the conforming loans can be easily sold, these loans are much less common to be sold. Many times they involve private lenders or financial institutions lending with the intent of holding onto the loan for a longer time period.
Fixed-Rate vs Variable-Rate
Both fixed and variable rates have their pros and cons based on factors such as the rate environment, how long the home is going to be owned by the borrower, and the borrower’s tolerance for risk.
Fixed-rate – This type of loan is just as the name suggests: a loan with a rate that is fixed over the life of the loan. The rate and payment amount are fixed after closing the loan. The rate and payment (principle and interest portion) stay the same over the entire loan.
Adjustable-rate – This loan has a rate than can adjust over time. Generally, the loans have an adjustment period and interest rate caps. The adjustment period signifies how often the rate can change. For instance, a 1-year adjustable mortgage is subject to change upon the anniversary date every year, but it does not have to change. Interest rate caps tell how much the rate can change. They can limit the maximum change per year and the maximum change over the life of a loan. A 30-year adjustable-rate mortgage may state that is can change a maximum of 1% per year but can only change a maximum of 7.5% over the original rate over the entire 30-year term.
Conventional vs Government Loans
Conventional and government loan types are determined by who insures the loan.
Conventional – Conventional loans are simply mortgages that are not insured by the government. Loans underwritten as conforming aren’t necessarily government-insured just because they are underwritten to government guidelines. However, some are privately insured due to certain factors, the most common being high loan-to-value. This insurance is usually paid for monthly as an addition to the monthly payment.
Government-insured – Government-insured loans include the following:
VA Loan – These loans are insured by the United States Department of Veteran Affairs (VA) and are offered to veterans and their surviving spouses. The loan is actually guaranteed by the VA, meaning that, as long as the VA’s guidelines have been followed, the lender will be protected against loss if the buyer defaults. Another significant feature is that VA loans can qualify for up to 100% financing. An additional funding cost for this type of loan can be between 1.25% and 3.30% and can be financed into the loan.
FHA Loan – These types of loans are backed by the United States Federal Housing Administration (FHA). These offer a much lower down payment option than most loan programs. The maximum loan-to-value is 96.50%, and FHA allows less strict guidelines on forms of down payments than many programs. The downside to FHA loans is that they charge insurance on top of the regular payment. The annual cost can be up to 1.55% annually in addition to an up-front 1.75% fee.
USDA Loan – These loans are guaranteed by the United States Department of Agriculture (USDA). They allow financing up to 100% loan-to-value, much like VA loans. These do have both income and location restrictions. The property being purchased must be in a rural area as defined by the USDA. Additionally, the loan application may only have income up to 115% of the median income for the area.
All of these different options aren’t necessarily independent of each other. For instance, USDA might only offer a fixed-rate option. However, an FHA loan can offer both fixed and adjustable rates. Conventional loans can be conforming or non-conforming and have fixed or adjustable rates. These are simply brief explanations of some loan options available.
