In the world of lending there are countless factors involved in a securing a loan for a home purchase. This article will give you an overview of the three main loan programs available. When you begin researching loan programs, be sure to contact a mortgage professional for more information and the latest market updates and changes.
FHA-Insured Loans
An FHA loan is a loan insured by the Federal Housing Administration. The FHA was created in 1934 to increase home construction and reduce unemployment through loan insurance, which essentially lowers the risk to the lenders creating the loan. During tough real estate times, FHA loans step in the spot light and become more important because they allow homeowners to obtain loans often at lower rates and with better terms than conventional loans. However, when times are good, and investors are willing to carry higher levels of risk (2005 boom) conventional loans will offer the more attractive terms for home buyers.
In today’s market conventional loans often require 5 – 10% of the purchase price as a down payment and don’t offer the most competitive interest rate. Due to the government insured aspect, FHA loans can have down payments as low as 3% and will allow the seller to contribute (give) up to 6% of the purchase price of the home to the buyer to help them move in. At the time of this post, the government is talking about increasing the down payment amount and getting rid of the seller assistance aspect. The changes made to the FHA loans often reflect moves towards making sure home owners are capable of moving into their home and making the payments for long periods of time, which creates a more stable real estate market.
Conventional Loans
Conventional loans are not guaranteed or insured by the government and therefore do not conform to the same strict guidelines as the FHA loans. A traditional conventional loan requires the home buyer (borrower) to bring in 20% of the purchase price as the down payment and remaining 80% will be financed as a conventional loan. Because the buyer is putting down such a large amount, these loans are often considered low risk and do not require any form of insurance.
In recent years, conventional loans have evolved to meet the needs of the home owner with very little to put down on a home. In this scenario, the buyer would come in with less than 20% down, and would have one of two options. Here is an example to explain the options.
Mr. and Mrs. home buyer decide to purchase a home for $100,000. A traditional conventional loan would have the buyers bring in $20,000 for a down payment and the remaining $80,000 would be financed / mortgaged. Now, If the buyer only had $10,000 for a down payment these are the two options they could choose from.
Option 1: Obtain one large loan for $90,000. Because the buyer would be financing more than 80% of the home’s value/purchase price with the first loan, the buyer would pay private mortgage insurance or PMI. This insurance protects the lender writing the loan in the event the buyer defaults on their loan. The theory is, the higher the loan to value ratio (amount loaned vs. the value of the home), the less invested the buyer is and the more likely they will default for any assortment of reasons.
Option 2: As a way to avoid paying PMI, the borrower can obtain two loans. The first loan would be for $80,000 and the second loan would be for $10,000 and the remaining $10,000 would go towards the down payment. Because the first loan is at a 80% loan to value (ltv) there would be no insurance premium (PMI). The catch with this loan is, the borrow would most likely pay a higher rate on the second loan of $10,000. Instead of paying for mortgage insurance, the borrower would be paying a higher premium on the second loan. The higher interest rate is how the lender can justify the risk of the second loan.
The second option is how a lot of home owners ended up financing 100% of their home and stretching their financial limits a little too much.
VA-Guaranteed Loans
VA loans are guaranteed like FHA loans, but the Department of Veteran Affairs does the guaranteeing. VA loans were created to help veterans purchase or construct homes for eligible veterans and their spouses. The VA also guarantees loans to purchase mobile homes and plots to place them on. A veteran meeting any of the following criteria is eligible for a VA loan:
- 90 Days of active service for veterans of World War II, the Korean War, the Vietnam conflict and the Persian Gulf War
- A minimum of 181 days of active service during interconflict periods between July 26th, 1947 and September 6, 1980
- Two full years of service during any peacetime period since 1980 for enlisted and since 1981 for officers
- Six or more years of continuous duty as a reservist in the Army, Navy, Air Force, Marine Corps, Coast Guard, or as a member of the Army or Air National Guard.
There is no VA dollar limit on the amount of the loan a veteran can obtain, the limit is determined by the lender. To determine what portion of a mortgage loan the VA will guarantee, the veteran must apply for a certificate of eligibility.
Bottom Line
Just as the real estate industry continually changes, the mortgage industry is also evolving on a daily basis. The rule of thumb for both industries is that 50% of what you know today, will be out of date and useless in three years. This emphasizes the importance of discussing your needs with a qualified loan officer who is continually educating themselves and staying on top of the market.
