The lending world is a very complex one and your lender is by far the best source for information which is why I always share the names and contact information for several lenders with whom I have worked in the past. It still doesn’t hurt to have some idea of what they are talking about when you enter their domain. I have broken down the basic loan types and structures as well as described a few options for special circumstances to help make the lending process a bit easier.
First of all, you need to be aware that there are numerous loan types and lenders are always coming up with creative solutions to help their clients. Here are the basics:
- Conforming vs. Nonconforming
The main difference between the two is that one follows the guidelines set forth by Fannie Mae and Freddie Mac (GSE eligibility) and the other does not. In most cases the underwriting issue is with the loan amount. Anything over the amount set by Fannie Mae and Freddie Mac would be considered a jumbo loan and is subject in most cases to a higher interest rate because the risk is higher. That dollar number is subject to change yearly and is set higher in Alaska and in Hawaii.
- Conventional Loans vs. Government Loans
- Simply put, a conventional loan is neither insured nor backed by the federal government. This is why qualifications for conventional loans are a bit stricter and the amount needed for down payment is often higher. Recently, that number has been lowered, but you will still need to put down 20% to avoid paying private mortgage insurance.
- Government Loans
- FHA – stands for Federal Housing Administration and that is the entity that backs these loan types. It is managed by HUD (Housing and Urban Development.) Many people think these loans are limited to first time home buyers when in fact, they are open to a number of different borrowers. This program allows you to borrow money with as little as 3% down; however, you will have to pay for mortgage insurance for the life of the loan which will increase your monthly payments.
- VA – Veteran’s Affairs backs these loans and is a program available to military members and their families. These programs are also insured and backed by the federal government. The biggest advantage of these loans is that the borrower needs no down payment — 100% of these loans can be financed.
- USDA/RHS – United States Department of Agriculture offers loans to those borrowing for purchase in rural communities who meet certain income requirements. Generally, it cannot be higher than 115% of the adjusted area median income. These median incomes vary by county and the label of “rural” is also frequently changing, especially in high growth areas.
- Fixed Loans –many different structures can be created at your lender’s discretion, but these are the basics.
- 30 Year Fixed – your basic loan. This is just as it seems. It is an amortized loan that has a fixed rate and is designed to be paid off in its entirety in thirty years. Your monthly principle and interest payment would remain unchanged; however, if you escrow taxes and insurance and those fees increase (likely) your monthly note will also increase.
- 15 Year Fixed – ditto above, but over 15 years vs. 30.
- ARMS – Adjustable Rate Mortgages. Basically, this loan structure fluctuates according to a fixed structure. This is a rather risky loan.
- One Year Arm – the loan rate changes yearly. Home borrowers who choose this structure often do this when they do not intend to hold onto the property for any great length of time.
- 10/1 ARM – This rate is fixed for the first ten years and then rises after that. It can be a good choice for borrowers who are certain they will be selling within 10 years or are making extra payments to quickly raise equity.
- 5 ARM–same as the 10, but for 5. Far more common than the 10.
- 2 Step Mortgage – has one rate for a certain number of years and another for the remaining years.
- Balloon Mortgages – these last for a much shorter time and operate much like a fixed-rate. For the first part of the mortgage, the borrower is predominantly paying the interest and then pays the remainder of the note at the end of the term. This can be extremely risky and is most often seen in construction loans.
- Interest Only Mortgages – RARE. Not to mention risky. And very little benefit. If you need to do this, you may need to reconsider renting for the time being.
- Loans with Pre-Payment Penalties – this can be a part of any loan program and you should always ask your lender about it to be sure you will not incur it.
- Other Loan Programs and GOVERNMENT ASSISTANCE PROGRAMS
- Teacher Next Door Program – HUD developed this program to encourage home ownership among educators in low to moderate income areas.
- Good Neighbor Next Door Program – program designed to encourage home ownership among civil servants such as teachers, policemen, and firemen.
- HUD’s Home Program – available to low income buyers in certain qualifying areas.
- ADDI – American Dream Down payment Assistance Initiative is available for first time home buyers buying a single family, residential home. Income restrictions exist; a buyer cannot have an annual income in excess of 80% of the median for the area.
- Zero Down Payment Act – eliminates the down payment requirement with FHA for families who can easily afford the monthly payments but do not have the cash reserves for a down payment. The lender is charged a higher fee for insurance which may deter many lenders from offering it. Contact HUD for more information.
- EEM – stands for Energy Efficient Mortgage Program and is another loan type offered through FHA. This can be useful to any home buyer who is looking to roll the cost of any energy improvements into the loan. This is insured by HUD.
- 203K – This is an FHA loan designed to rehabilitate distressed properties. Certain qualifications must be met, primary residency being one.