How they work: “The dominant number of loans made in the conventional market use Fannie Mae and Freddie Mac guidelines for conforming loans,” says John Councilman, federal housing chairman for The National Association of Mortgage Brokers in McLean, Va. The U.S. government bailout of Fannie Mae and Freddie Mac may affect both entities’ underwriting guidelines going forward, but no changes have been made yet.
Conventional loans are “conforming” if they are generally $417,000 or less for a single-family home. Conforming loan limits can be higher in pricier regions of the country. For example, in such states as Alaska and Hawaii, it’s $625,500.
There are also established guidelines for borrower credit scores, income requirements and minimum down payments. For example, most conventional loans require somewhere between 5 percent and 20 percent down.
“Right now those guidelines are changing frequently but they should have at least a 620 credit score,” Councilman says. “Anything below a 740 credit score and they (lenders) are going to start adding fees which can be quite sizable, in the several-percent range, as borrowers’ credit scores drop compared to Loan to Value (LTV).”
Conventional loans can be conforming or nonconforming. Loans above the lending limits set by Fannie Mae and Freddie Mac are called nonconforming or jumbo loans.
Most conventional mortgages have either fixed or adjustable interest rates. Typical fixed interest rate loans have a term of 15 or 30 years. A shorter-term loan usually results in a lower interest rate. Adjustable-rate mortgages, or ARMs, fluctuate in relation to the rate of a standard financial index, such as the LIBOR. Monthly payments can go up or down accordingly.
How they work: Consumers who served stints in the U.S. military or who are on active duty may want to look into a VA Home Loan administered by the U.S. Department of Veterans Affairs.
Qualified veterans can purchase a primary residence with no money down, as long as the purchase price doesn’t exceed the appraised value of the property and the seller is willing to pay closing costs.
The VA does not loan money, but it does back loans made by private lenders to qualified veterans.
The veteran’s basic entitlement under the loan program is capped at $144,000. But for the past several years, the VA has been guaranteeing up to 25 percent of the total loan amount based on the conforming loan limits allowed by Fannie Mae and Freddie Mac.
The conforming loan limit for 2008 is generally between $417,000 and $625,500, but depending on where the property is located in the U.S., can exceed those amounts.
“The VA guarantees the basic entitlement, but the veteran can still get a loan up to $417,000 with no money down and in some high-cost places it’s up to $729,750,” says Judith Caden, director of loan guaranty services for the U.S. Department of Veterans Affairs.
Veterans still need to qualify with respect to income and credit score, and may need money for closing costs. However, the VA program permits the seller to pay closing costs. Borrowers may also need money for the earnest deposit (money the seller usually requires to remove the property from the market while the sales contract is under negotiation).
Loan refinances are restricted under the VA Home Loan Program unless the borrower is refinancing from one VA loan to another.
“If they wanted to get do a cash-out refi, they would be limited to $144,000, or if they were trying to refinance from a conventional loan to a VA loan, they would be limited to $144,000,” Caden says.
Service eligibility and entitlement guidelines can be tricky, so it’s best to check with the VA before applying for a loan.
One important caveat: A dishonorable discharge will disqualify a veteran from the loan program. However, it’s possible to make an appeal to change the status of the discharge.
Cost: Private mortgage insurance is not required, but the VA charges an upfront VA funding fee, which can be rolled into the loan or paid by the seller. The funding fee helps pay for the cost of a VA loan, reducing the cost to taxpayers. The fee can be as low as 0.5 percent for Interest Rate Reduction Refinancing Loans, which enable veterans to refinance an existing VA loan to one with a lower rate. And the funding fee can be as high as 3.3 percent for subsequent users of the VA home loan program.
For first time borrowers, the funding fee ranges from 2.15 percent for regular military to 2.4 percent for Reservists and National Guard borrowers. A down payment can result in a lower fee. For example, the funding fee for a member of the regular military who puts between 5 percent and 10 percent down will be reduced from 2.15 percent to 1.5 percent. For down payments greater than 10 percent, the fee goes down to 1.25 percent. For members of the Reserves or National Guard, the fee falls to 1.75 percent and 1.5 percent, respectively, in these cases.
How they work: The Federal Housing Administration, a part of the U.S. Department of Housing and Urban Development, or HUD, claims it has backed more than 35 million mortgages since its inception in 1934.
The FHA, like the VA, does not lend money. It provides government backing in the event that the borrower defaults on the loan. FHA loans can be fixed-rate or adjustable-rate mortgages, but the majority of loans are fixed-rate mortgages, according to the FHA.
“Right now, it’s the fastest growing loan program out there,” says Michael Ashley, chief business strategist with Lend America, in Melville, N.Y.
Ashley says that growth in the FHA loan program is being fueled by borrowers with newly adjusting ARMs looking to refinance into fixed-rate loans, as well as borrowers whose credit scores fall somewhere between excellent and subprime.
The FHA loan program has been revamped, at least temporarily, by new federal housing legislation signed into law in July 2008. Effective Oct. 1, 2008, changes include the following.
- Down payment gifting by the seller or any person/entity that financially benefits from the transaction will be prohibited.
- The minimum down payment will increase from 3 percent to 3.5 percent.
- The FHA may charge an upfront risk-based mortgage insurance premium, or MIP, of up to 3 percent. First-time homebuyers will pay no more than 2.75 percent. However, a 12-month moratorium beginning Oct. 1, 2008 caps the MIP at 1.75 percent.
- The new law temporarily raises the maximum loan limit for a single-family home to $625,500 ($729,750 or more in high-cost areas).
- It provides relief for borrowers wanting to refinance into an FHA-backed loan by allowing the lender to forgive all debt above 90 percent of the home’s current appraised value. The borrower can then find another lender to refinance the remaining 90 percent into an FHA loan.
Borrowers have traditionally been able to get FHA loans with moderate to high debt-to-income ratios, or DTI. For example, many financial experts recommend your mortgage payment should not exceed 25 percent of your take-home pay. FHA loans enable borrowers to qualify for higher mortgage payments. Of course, a higher DTI means you commit more of your income to the mortgage payment and less to other needs.
“The standard without compensating factors is 31 percent to 43 percent (DTI), but it can go higher if based on compensating factors,” Ashley says, referring to a good credit score.
One of the benefits of the FHA loan program is that many lenders are more willing to look at a borrower’s overall credit picture rather than basing a loan decision on automated underwriting software alone. Such software generally incorporates a credit-score requirement.