If the last time you shopped for a mortgage was over a decade ago, then you might be surprised by how much the menu of loan offerings has changed. Immediately following the housing crash, mortgage meltdown, and economic recession of the late 2000s, loan programs began to disappear and an overhaul of industry guidelines and regulations reshaped the lending landscape.
So how do you know what’s available, and more importantly what’s the best option for you? If the last time you shopped for a mortgage was in the early days of the highly regulated industry recovery, you’ll be glad to know that many useful programs are once again available in addition to the standard fare.
Home Equity Loans and HELOCs
As home values fell sharply in many parts of the country, home equity loans and HELOCs became very difficult to find. Even if you had an existing line of credit, many lenders exercised their option to shut these down due to collateral depreciation. It took a while, but as property values mostly returned to their pre-crash levels, investors once again became interested in buying these types of loans.
Loan programs tend to come and go based on the level of interest they receive from the investors who buy mortgage backed securities. It may sound backwards, but just because people want home equity loans doesn’t mean that lenders will offer them — there has to be demand from investors.
Non-QM Loan Products
The term non-qualified mortgage (non-QM) sounds like something you wouldn’t want to have, or worse — a predatory loan. Thankfully, this isn’t the case with the non-QM loan products that are available today. A loan is deemed “non-QM” if there is any feature that doesn’t conform to the guidelines set by Fannie Mae and Freddie Mac.
I’ll bet you’re thinking “Wait a minute, aren’t those guidelines in place to protect consumers from bad loans?”, but you’re only seeing part of the picture there. Fannie Mae and Freddie Mac guidelines are used to protect against risky borrowing: for consumers, lenders, and investors alike. Just because a loan is labeled as non-conforming doesn’t mean there’s anything wrong with it.
Consider this example: When a lender decides to offer a program with reduced documentation requirements, allowing a self-employed borrower to show their business cash flow over 12 months of bank statements rather than provide two years of tax returns, the extra risk the lender is taking here is factored into the cost and interest rate of the loan.
The purpose of non-QM loans is to open up lending options that carefully and responsibly evaluate risk factors, and then pricing them in a way that mitigates any risks. If there are too many risky characteristics, or the borrower’s ability to repay the loan is in question, then the loan still won’t be approved. This commonsense, analytical approach allows for some much needed gray area, as opposed to the black and white nature of Fannie and Freddie.
What’s Conventional about a Conventional Loan?
Conventional loans are non-government loans, meaning they aren’t part of FHA, USDA, or VA programs. There are a few sub-categories of conventional loans that can lead to some confusion, so I’ll break them down for you here:
- Conventional Conforming: loans at or below the conforming loan limit (currently $484,350)
- Conforming Jumbo (or High Balance): loans greater than the conforming loan limit, but less than the county loan limit – set by each county across the U.S.
- Non-Conforming Jumbo: loans greater than the county loan limit
- Non-Conforming Other: loans that, due to unique features, don’t fall into one of the other categories, regardless of loan size. This includes non-QM loan products
A conventional loan is the obvious choice if you’re not looking for a specific benefit that’s only offered by a government loan program, such as 100% financing for military veterans on a VA loan or a lower credit score requirement offered by the FHA. The majority of refinance and purchase loans in the U.S. today are conventional loans, I’ve originated a lot of these loans myself.
According to the Consumer Finance Protection Bureau, conventional loans tend to cost less than FHA loans, for example, but they’re more difficult to qualify for. Generally, you’d want to choose a conventional loan if you’ve got 20% equity or more in your home (or are planning on putting 20% down on a purchase), if your credit scores are well above 620, or you’re financing a second home or investment property.
You certainly aren’t required to put 20% down on a conventional purchase, however private mortgage insurance (PMI) is required if you don’t. If you have stellar credit and a low debt-to-income ratio, it’s less expensive than it would be otherwise. There are even special programs like Fannie Mae’s HomeReady and Freddie Mac’s HomePossible that allow for as little as 3% down and have reduced PMI rates as well.
Government-Backed Loans vs. Loans From the Government
Government loans, like FHA, USDA, and VA are more accurately described as government-backed loans because the U.S. government doesn’t actually lend mortgage money to homebuyers or homeowners. Rather, they set program guidelines and certify or endorse certain lenders to make loans that are insured or backed by the government.
The FHA has established some of the most accessible government loan programs, with low down payment requirements (as little as 3.5%), more lenient credit history and score requirements, and no additional qualifying criteria (like rural property for USDA, or VA eligibility).
This is the loan of choice for a lot of first-time homebuyers, as it allows for gift funds towards your down payment, and even permits a non-occupying co-borrower to essentially co-sign on the loan to help with qualifying. FHA loans are also the go-to choice if you’ve had credit troubles in the past, such as a bankruptcy or foreclosure, because the seasoning requirements (a.k.a. wait times) before you can get another loan are shorter than they are for conventional loans.
USDA loans are also known as rural development loans because the property has to be located in an eligible rural area (as determined by the USDA). You can check to see if a property is eligible using the USDA eligibility tool.
One of the main benefits of USDA financing is your ability to finance 100% of the purchase price of the home, however you’ll have a monthly mortgage insurance premium to pay no matter how much you put down. There are minimum income requirements of course, but there are also maximum income limits for the household on USDA loans, based on the location of the home. These can also be checked using the USDA eligibility tool.
The VA insures loans to eligible military veterans as part of a series of entitlement programs enacted since WWII. VA approved lenders may have a direct endorsement from the VA and underwrite loans themselves or they may send loan packages to the VA for underwriting.
Either way, the process can be more time consuming than other loan types and the funding fee means it could be more expensive as well. So what do VA loans have going for them?
Historically, VA interest rates are often lower than conventional mortgage rates. They also allow 100% financing without charging a monthly mortgage insurance premium and are assumable loans (meaning they can be transferred with the sale of the property, which could be enticing to buyers if the rate and terms are favorable).
What Makes a Loan Jumbo?
A jumbo loan is simply defined as a loan that’s larger than the county loan limit. The minimum varies by county, but there’s theoretically no limit to how big a jumbo loan can be. Since jumbo loans are considered non-conforming, jumbo lenders often create their own guidelines outside of Fannie Mae and Freddie Mac requirements to accomodate the needs of their clientele.
You could have complex income structures, self-employment income, or need asset-based lending — when we’re talking about jumbo home financing, there are often layered levels of complexity that require consideration on a case-by-case basis. If your loan size is larger than the limit for your county, a jumbo loan is what you’re looking for. Be prepared for higher minimum credit score requirements, increased asset and reserve requirements, and a more in-depth degree of underwriting scrutiny.
Construction Loans and Rehabilitation Loans
New home construction basically came to a halt by the end of the 2000s, and even now builder sentiment is decidedly cautious. This, coupled with a dwindling housing supply, has led to an increase in construction and rehabilitation financing as people are deciding to build their dream homes, or restore a fixer-upper back to its former glory.
Construction loans are generally short-term financing solutions, used to pay for materials, labor, and sometimes land as a new home is built or an existing home is renovated. These non-conforming loans are either set up as construction-to-permanent or construction-only.
They may be converted into a long-term loan once the construction is complete, or they may have a balloon payment feature requiring you to refinance or pay the loan off in full. Construction loans are the ideal solution if you want to build your next home (or completely renovate your current home), but don’t have the ability or desire to finance everything out of pocket while the work is being done.
Rehabilitation loans are offered both by construction lenders and by traditional lenders under specific programs. The FHA offers a rehab loan program called 203(k) that allows you to finance the cost of approved renovations and repairs along with the purchase or refinance of a home, up to 110% of the projected value (after renovation). While both the VA and USDA have guidelines for similar programs, they’re much less common and it’s difficult finding lenders who offer the option.
Which Loan Type is Right for You?
Figuring out which loan type is right for you doesn’t have to be a struggle. There are three main areas to focus on that will help you narrow it down: your income, assets, and credit. If your income calculation is straightforward, then determining your debt to income ratio will allow you (and your lender) to figure out which loan programs you qualify for.
- Non-QM: Best for complex income scenarios and unique product offerings that don’t fit Fannie Mae or Freddie Mac guidelines.
- Conventional: Generally require at least 5% down, but are more favorable and don’t carry mortgage insurance if your able to put 20% down.
- FHA: These loans have the least strict credit requirements, both for minimum scores and seasoning requirements for derogatory information. They also allow for a 3.5% down payment.
- VA: For eligible veterans, these loans allow up to 100% financing without any mortgage insurance to pay for and offer low interest rates.
- USDA: For eligible rural properties, these loans allow up to 100% financing.
- Jumbo: Best for loan amounts that are higher than county limits. Many jumbo loan products require at least a 20% down payment and are the most stringent in their credit qualifying requirements.
Now that you have a better idea of what types of loan programs are available nowadays, and if they’re right for your situation, check out the Conventional Mortgage Calculator or FHA Mortgage Calculator feature to estimate your monthly payments or to see how big a home you can comfortably afford!