Choosing a Mortgage
A mortgage is a loan to purchase a property. The mortgage company you select will pay the seller or its lender for the property.
After closing, the buyer makes installment payments to repay the mortgage company in full (with interest, property taxes, and insurance included) over a set period of time.
You may choose between several types of mortgages, but a great starting point is deciding between a government-backed or conventional mortgage. Both require proof of income and credit checks, but they have their differences. Let’s compare.
Government-backed Conventional Loans
Conventional mortgages are a type of loan that does not include a guarantee and is not insured by the federal government. In other words, if the buyer defaults on a mortgage, the lender is not financially covered by the government’s Federal Housing Administration (FHA). Conventional loans are among the most common mortgage, even though it is the most difficult type of loan to receive approval on. Conventional loans often require a higher credit score of at least 640 and a debt-to-income ratio of 43% or less and can be approved with as little as 3% down payment for a fixed interest rate loan and 5% variable interest rate loan. Keep in mind that the recommended down payment is 20%.
If you cannot make the 20% down payment, conventional mortgages will require private mortgage insurance (PMI), which will help cover the lender if the buyer defaults. If you don’t have the full 20% down payment, the closer you get to the 20% will continue to help lower your PMI monthly payment. The cost of PMI is added to the monthly mortgage payment. Homeowners request the PMI be removed when the principal balance falls below 80% of the home’s original value. Even if you don’t request the PMI to be removed, the lenders must be automatically removed when the balances reach 78% of the original value of the home.
Conventional loans fall into two categories.
This type of loan conforms to the lending standards set by Freddie Mac and Fannie Mac. What that means is that the loan will be purchased by Freddie Mac and Fannie Mac. This is good for the lender because they collect the loan money from Freddie Mac or Fannie Mac, which is earlier than going through the 30-year repayment process to collect the full amount of the loan.
This type does not conform to the Freddie Mac and Fannie Mac lending standards. This is not the most favorable to the lender because they can’t be sold as quickly. These typically have a slightly higher interest rate and credit score requirements because the lender is assuming more risk not being able to sell the loan.
Government-backed Mortgages Have Three Options
Option #1 FHA Mortgages
FHA mortgages are loans that are insured by the Federal Housing Administration. These loans have lower limits on how much you can borrow and usually fewer financial requirements than conventional mortgages. FHA mortgages are the go-to choice for first time home buyers. With a credit score of at least 580 and at little at 3.5% down payment, you could be qualified for a loan. Even without a mediocre credit score of 500-579 and a down payment of 10%, you could still potentially qualify for an FHA mortgage. Similar to conventional loans, these loans require the buyer to obtain PMI if you don’t put down 20%. Keep in mind this cost is usually added to the monthly mortgage payment). The debt-to-income ratio requirement is the same as the conventional loan, 43%.
Lastly, to receive an FHA loan, that home must be your primary residence. FHA loans will not be approved for investment properties. For more details visit: https://www.fha.com/fha_loan_requirements
Option #2 VA Mortgages
VA mortgages are from the U.S. Department of Veterans Affairs and available to members of the military. VA loans may not require a down payment, or offer reduced down payments and private mortgage insurance is not required. VA loans do have some extra costs and traditionally require a funding fee set at 1.25% to 3.6% of the loan amount.
Option #3 USDA mortgages
USDA mortgages are part of a program from the United States Department of Agriculture for homebuyers purchasing in rural areas and meet specific income requirements. These loans often need to be funded by a USDA approved lender and require an upfront fee of approximately 1% of the purchase price. USDA mortgages do not require a down payment or mortgage insurance.
Glossary of Common Mortgage Terms
Adjustable-Rate Mortgage (ARM) — A loan that recalculates the interest rate. After the ARM fixed-rate period ends, the interest rate mortgage moves up and down based on the index it is tied to. The index is an interest rate set by market forces and published by a neutral party. There are many indexes, and the loan paperwork identifies which index a particular adjustable-rate mortgage follows.
Annual Percentage Rate (APR) — The yearly cost of credit over the life of a loan. Typically includes interest, service charges, points, loan fees, mortgage insurance, and various other mortgage items.
Closing — The process of transferring funds to pay for a property, paying fees and closing costs, and the signing of documents that transfer the deed for a property from a seller to a buyer.
Closing Costs — Charges incurred and due for obtaining a mortgage loan and transferring real estate title.
Closing Date — The date set by all parties to finalize the transfer of property and to be referenced within the mortgage contract for legality.
Conventional Mortgage — Type of loan that is not insured by a government agency (such as FHA or VA).
Convertibility — The ability to change a loan from an adjustable-rate schedule to a fixed rate schedule.
Default — A breach of a mortgage contract. Usually from not making mortgage payments for a certain period.
Escrow — The handling of funds or documents by a third party on behalf of the buyer or seller.
Federal Housing Administration (FHA) — A federal government agency that insures mortgages for financial backers.
Fixed-Rate Mortgage — A mortgage with an interest rate that remains constant over the life of the loan.
Funding Fee — A one-time fee applied to VA mortgages paid by qualified service members or surviving spouses.
Mortgage — A loan with a contract for the buyer to agree to repay principal and interest to the financial institution funding the sale, with the property used as collateral while payments are repaid in installments over a specified period.
Principal — The full amount borrowed in a loan that excludes interest and other charges.
Private Mortgage Insurance (PMI) — A type of mortgage insurance for conventional loans usually required for loans with smaller down payments (less than 20%).
Refinance — To finance (something) again, typically with a new loan at a lower rate of interest.
Settlement — See closing.
Title — A deed or certificate legally confirming the ownership of property. During a mortgage, the financial intuition that funded the purchase money will legally own the property and hold the title until the buyer has met all mortgage financial requirements.
Veterans Administration (VA) — A federal government agency for active or honorably discharged veterans and surviving spouses that offers mortgages with reduced or waived down payments and/or mortgage insurance, but a funding fee may be applied.