Mortgage Loan Programs Explained

Determining the right mortgage loan program for a home purchase or refinance is a financial decision that should be well understood. Unfortunately, unethical loan officers can steer clients into a loan that pays the largest commission and not the most beneficial for the borrower. Mortgage interest rates are only one component of a loan program.

Below is a description for conventional and government loan programs that can serve as a borrowers guide to selecting the right loan for their circumstances. There are also first time home buyer programs available that offer lower down payments and flexible qualification guidelines.

Conventional Loan

What is a Conventional Loan?

Historically a conventional loan was a mortgage that was privately held by a bank and was not insured by a federal agency like the Federal Housing Authority. Since the 1930s, banks began underwriting conventional loans based on guidelines that would allow the loan to be sold on a secondary market. The two largest underwriting entities who set the guidelines for selling loans on the secondary market are Fannie Mae and Freddie Mac. Today, a majority of banks sell their conventional loan portfolio on the secondary market.

A conventional loan can have a fixed rate (typically 30 or 15 year amortization periods), an adjustable rate (ARM) and have interest only payment periods. Prior to the mortgage crisis of 2007, conventional loans offered more flexible lending guidelines, multiple property types, more lenient appraisal criteria and were open to many different consumer credit profiles. Today, underwriting guidelines have been tightened to lessen consumer default rates by requiring higher down payments and tighter credit standards.

Is a Conventional Loan right for me?

As a rule of thumb, conventional loans are for borrowers with good credit, at least a 20% down payment and may be financing an amount which exceeds the Government loan limits.

For refinance loans where the loan value is less than 80% of the home value and for purchase loans where the buyer is making a 20% down payment, a conventional loan will provide a lower monthly payment because mortgage insurance is not required.

FHA Loan

What is an FHA loan?

FHA also known as the “Federal Housing Administration” was founded by Congress in 1934 and became part of the Department of Housing for Urban Development (HUD) in 1965.  Its primary purpose is to provide mortgage insurance on home loans made by approved FHA lenders throughout the United States.

What is mortgage insurance?

Mortgage insurance provides an approved FHA lender with protection against the possibility a borrower may default on their mortgage.  In this unfortunate event FHA will bear the brunt of the defaulted loan and pay the claim.

How can this benefit you as a borrower?

Unlike conventional loans which carry strict underwriting guidelines determined by the lender, FHA insured loans are much more flexible in areas such as down payment, credit scores and household income ratios.  For an example, FHA insured loans currently require only a 3.5% cash investment from the borrower as opposed to 20% required by most conventional lenders.

What expenses can you expect with mortgage insurance?

There are two expenses passed to borrowers with FHA mortgage insurance that you need to be aware of.  First, an upfront premium of 1.75% of the money purchase price will be included in the closing costs of the loan, so take note.  Second, an annual premium ill be calculated in basis points and remitted monthly based upon the initial “loan to value” ratio and the length of the mortgage itself.  Both of these expenses are currently eligible for tax deduction and should be taken advantage of.  In most cases mortgage insurance will drop off after 4-5 years or when the remaining balance of the loan is 78% of the value of the home.

Who is FHA lending most appropriate for?

The main purpose for FHA financing is to assist those with little monies for down payment or ones with less than favorable credit to secure home financing.  People often mistaken this type of financing for “first time home buyers” only when in fact FHA loans are available to everyone.  Whether it be your first or fifth home, purchasing or refinancing, FHA provides flexibility to everyone.  If refinancing, the current loan does not have to be an FHA loan.  FHA loans are also assumable; this allows one to take over an existing loan without incurring the cost of securing a new loan.

One of the greatest disadvantages to FHA financing is that FHA places a limit on the loan size an individual may borrow.  Please visit the FHA Loan Limits website to determine the maximum loan limits in your area.

There are several FHA loan programs available, everyone’s financing situation is different and you should talk to a qualified specialist to determine if FHA financing available and most suitable for you needs.

VA or Veterans Home Financing

VA loan programs offer flexible, low cost, no or low down payment, less than perfect credit home lending options for veterans and present military personnel.

Who is eligible?

An individual is eligible as a veteran if they’ve served active duty in the Army, Navy, Air Force, Marine Corps, or Coast Guard after September 15, 1940 and parted in any way other than dishonorable.  Required length of duty is required and should be considered in determining eligibility.

What are the benefits of using VA financing?

In most cases VA offers 100% financing of the home without carrying mortgage insurance.  VA loans are guaranteed or insured by the VA in the event the borrower is unable to make his or her mortgage payments.  VA loans are also assumable and have no pre-payment penalties.  The loan can be used to purchase, refinance, build or purchase and rebuild an existing home.  Home improvements with energy efficient features such as solar, heating and cooling systems, weather proof windows and other efficient improvements maybe included in the financing.

What expenses can you expect with VA financing?

VA financing does come with a onetime funding to be paid by each Veteran financing a home through VA.   The upside here is your mortgage is insured and the fee may be included in the financed loan amount.   There are consumer protective guidelines in place to protect the borrower from paying too much for his or her loan such broker lending and commission fees.  Aside from the funding fee you can expect standard closing costs such as appraisal, credit, recording and transfer of tax fees.

Jumbo Loans

Jumbo loans are mortgage loan amounts that are greater than or exceed standard loan amounts of conforming loan limits.

How is the Jumbo loan limit determined?

Jumbo loan limits determined and set each year by the Federal Housing Finance Agency.  This government operated agency regulates the 12 federal home loan banks including the agencies that used to set the loan limits, Fannie-Mae and Freddie-Mac.  Jumbo loan limits can change each year and tend be higher in luxury or high-cost areas such as Hawaii and the Virgin Islands.  Visit this link to determine the Jumbo loan limits in your area: Jumbo Loan Limits

What should you know about Jumbo loans?

Because Jumbo loans carry a larger debt value therefore carrying a greater risk factor, the interest rate (APR) attached will be greater as well.  In most cases interest rates on Jumbo loans can be as much as a quarter percent higher than conforming loan amounts.  Jumbo loans also require the borrower to have a much greater FICO score than FHA or traditional financing.

Are there ways around Jumbo financing?

Actually there are ways or financing options to consider in effort to avoid high interest payments.  Some lenders will consider providing a second mortgage at a lower balance and rate which can save you a great deal of money.  For an example, if your loan amount after down payment is $440,000 and requiring Jumbo financing, ask your lender to consider providing you with a second mortgage for $23,000 to bring your first loan to the current $417,000 conforming limit.  The reduced interest rate on your first mortgage along with your second mortgage may save you thousands of dollars in the long run.

Short and long-term mortgage debt adds up quickly with Jumbo financing, consulting with your financial advisor or professional is highly recommended before acting on such a transaction.