So you’ve finally landed that promotion, finished college, gotten married or have just gotten tired of throwing your rent money into an endless pit and are starting to investigate the housing market. Maybe you’ve even spotted a house that you feel a deep emotional attachment to – but before you step one foot inside, you need to estimate your mortgage payment and get your mortgage secured. There are lots of different types of loans to choose from, but how do you know which is best for your situation?
It’s not always easy to choose between common mortgage products – each type of loan program has its own advantages, depending on your particular circumstances. Some loan types have smaller fees, but require massive down payments; others may have smaller upfront fees, but will cost you extra throughout the loan’s life. There are loans just for Veterans and members of the military, and others for extra costly areas of the country and executive homes – it can be hard to sort through all the information. Have no fear, I’m going to break it all down for you.
Federal Housing Administration (FHA) Loans
The FHA was established in 1934 to aid the ailing housing sector. By the 1940s, FHA primarily was helping returning soldiers finance homes. But by the 1980s, it was helping insure private mortgages across the country. The FHA continues to stimulate the housing market in much the same way, offering insurance against losses to banks who lend to borrowers according to the FHA’s comparatively lenient criteria.
If you’re just getting started in the housing market and you don’t have much money in hand and a little more debt than you’d like, an FHA loan may be the right choice. These loans are the most forgiving of credit problems, allow a borrower to finance up to 96.5 percent of the cost of their home and can be manually underwritten to stretch debt to income ratios in specific circumstances for those borrowers who qualify for exceptions. You’ll find FHA loans through your local banks – brokers often shy away from them because they limit the fees lenders can collect.
Unlike a conventional loan, FHA loans require the payment of both an upfront and annual loan insurance premium, divided monthly. The upfront portion can be financed into the loan, reducing the money required at closing, but you’ll be paying interest on that money for the life of the loan; before borrowing with an FHA loan, consider the implications of financing that extra chunk. Along with that large upfront premium, you’ll be required to make a monthly loan insurance payment, further increasing your overall costs over the life of the loan, unlike with a conventional mortgage.
If you have no other choice than to borrow using an FHA loan, you’re probably still better off buying than renting — after all, you can refinance your FHA loan without penalty when your financial circumstances improve.
Department of Veterans Affairs (VA) Home Loans
VA loans are another option for borrowers with little free cash but decent credit, provided they’ve served in the military. You’ll need to obtain a Certificate of Eligibility through your lender or the VA Loan Eligibility Center before you will be able to close your loan, however. Qualifying for a VA loan is a lot different than any other loan on the market – the Department of Veterans Affairs places no strict limits on the credit eligibility or debt to income ratios of the borrowers they insure. Instead, most underwriting items are left to the discretion of the bank involved. Most banks will lend with standards similar to FHA, but they’re under no obligation to do so.
The Department of Veterans Affairs may not provide a lot of guidelines on who to loan VA funds to, but they’re very strict on what fees can be paid by borrowers and how much they can pay for things like closing costs. Items not reimbursed under “itemized fees and charges” on the HUD-1 form are limited to one percent of the loan amount in most cases, and those “itemized fees and charges” are tightly regulated.
Even though VA loans are an excellent option for many veterans, there are a few drawbacks. If you have plenty of cash and excellent credit, you may be able to find a better rate with a conventional loan, plus you’ll avoid the VA funding fee. In addition, some sellers may be nervous about accepting a real estate contract with VA financing attached, especially if they or their agent believe your loan may take extra time to close.
Conventional Loans
Conventional loans are the old standard, requiring borrowers have higher down payments, better credit and lower income to debt ratios to qualify when compared to FHA loans. In the past, you might have had trouble securing a conventional loan with less than 20 percent down, but today it only takes about 5 percent, which puts them in reach of many borrowers with outstanding credit. Unlike FHA loans, conventional loans aren’t insured, but purchased directly by Fannie Mae or Freddie Mac. Since banks don’t have to worry about keeping these loans on the books for any amount of time, they’re much more eager to make them.
There’s no upfront mortgage insurance, unlike an FHA product, but unless you have a 20 percent down payment, you will pay a monthly premium based on your loan amount and credit score. However, you’ll be able to cancel your mortgage insurance after two years if your home’s value has increased enough to give you 20 percent equity. In addition, you can avoid mortgage insurance if you borrow a second mortgage to cover the difference between your down payment and the 20 percent equity needed.
If you have problem credit, several different monthly debt payments or are fixated on interest rates, conventional mortgages might not be for you. The underwriting process is very unforgiving and rates are often slightly higher than FHA products, especially if you’re borrowing a second mortgage in order to avoid mortgage insurance.
Jumbo Loans
It may seem too simplistic, but a jumbo loan is just that – a loan amount that’s much bigger than the norm. Any loan that exceeds Fannie Mae or Freddie Mac’s cap for the area where the property is located is technically a jumbo, though there’s no real limit on how big a jumbo can get. These are the loans that are used to buy mansions and estates, but they aren’t any easier to secure than they are to pay off.
The requirements are stiff — a credit score of 700 or better, high down payments of 20 to 30 percent and solid proof of very high income are just a few of the things that jumbo lenders look for before handing over this kind of money. Since there is no insurance on a jumbo mortgage, lenders have to be extra careful who they lend to – one bad jumbo could break a small bank.
Unless you’ve just signed a lucrative movie deal or are shopping for an executive home, you’ll probably never rub elbows with the jumbo loan. If you do happen to fancy that kind of lifestyle, remember that the interest rates will be very high, making the payments very high. It may take some time to find a lender who will write the jumbo you’re looking for, so be sure to shop around.
United States Department of Agriculture (USDA) Loans
Not everybody lives in an area that will qualify for a USDA home loan, but for those that do they can be a much better deal than any other mortgage product. Rates are set by lenders, but they are typically fairly low and no down payment is required. The main program used to lend to home buyers is the Guaranteed Housing Loan Program, which allows buyers to roll eligible closing costs, lender fees and any allowable repairs into the loan, up to the value of the home.
Although it’s fairly easy for a borrower to qualify for this type of loan, there are several catches. First, the borrower must not have income exceeding 115 percent of the median income for their area. Secondly, the home must be located in an area targeted for rural development – these are typically very out of the way places that may suffer from aging infrastructure. Third, the home itself has to meet the USDA’s exacting standards, which can be difficult to meet if the home wasn’t built with USDA financing in mind.
Comparison Summary
| FHA Loans | VA Loans | Conventional Loans | Jumbo Loans | USDA Loans | |
Credit History | Credit scores as low as 580 may qualify. Accepts borrowers 2 years out of bankruptcy and 3 years out of foreclosure | No set credit scores to qualify, forgiving of credit problems | High credit scores needed to qualify | Extremely high credit scores of 700 or higher required | Credit can be less than perfect, borrowers with non-traditional credit may also qualify |
Borrowing Limit against Home Value | Can borrow up to 96.5 percent of home’s value | Can borrow up to 100 percent of home’s value | Can borrow up to 95 percent of home’s value | Can sometimes borrow 70 to 80 percent of home’s value | Can borrow up to 100 percent of a home’s value |
Income / Debt-to-Income Ratio | Accepts higher debt to income ratios, depending on borrower circumstances | Accepts higher debt to income ratio, depending on circumstances | Lower debt to income ratios required, no exceptions | Both debt and income are carefully scrutinized, extremely low debt to income required | Debt to income requirements are similar to FHA. Income limits of 115 percent of the area’s median income apply |
Loan Limit (Dollars) | Loan limit of $625,500 in high-cost areas, $271,050 elsewhere | Loan limit of $417,000 in most areas, up to $1,050,000 in high-cost areas | Loan limit of $417,000 for most areas, up to $625,500 in high-cost areas | There is no loan limit, but loans must exceed the established maximum for conventional loans in your area | No loan limits |
Mortgage Insurance | Must pay 1.75 percent of loan as insurance premium upfront, but can finance into loan. Annual mortgage premium equal to 1.35 percent of loan amount, divided equally into 12 monthly payments each year | Must pay VA funding fee of up to 2.4 percent of loan amount, which can be financed into the loan. No additional mortgage premiums or fees | No upfront mortgage insurance premiums required, though monthly premiums apply until loan amount drops below 80 percent of home’s value | Mortgage insurance is not required | Upfront mortgage insurance of 2 percent is added to the loan, plus a 0.4 percent annual fee, divided into monthly payments |
Product Availability | Limited primarily to banks due to low fixed fees, but some brokers may offer them | Typically offered by any institution that will make an FHA loan | Widely available from a variety of lenders | Loans have limited availability and terms differ greatly between lenders | Loans have limited availability, but many banks can underwrite them |
Other Eligibility Requirements | Limited to active duty soldiers who have served at least 90 continuous days, retired soldiers who served 90 continuous days during wartime or up to 24 months during peace and National Guard and Reserves Members serving 90 days of active service or 6 years otherwise. Soldiers cannot have been dishonorably discharged. Spouses of soldiers are eligible under certain conditions | Limited to qualified properties in eligible rural areas. Properties must be modest in size, design and cost, as well as being on a permanent foundation (mobile homes are allowed provided they are properly mounted) and conform to the Housing and Community Facilities Program Thermal and Site Standards. Eligible rural areas are subject to change as frequently as once each year |
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