Home Loan Options Which is Best, When & Why?

Home Loan Options
Which is Best, When & Why?

Dear Friends,

When it comes to mortgage financing, most of us know there are several different programs to choose from. Usually, there is a specific program that is best suited for each individual borrower.

Below, you can find a summary of the 4 major types of mortgage financing, and a brief analysis of their advantages, disadvantages, and when they may best suited for a particular buyer.

Conventional Loan

 

It is a misnomer from some that a buyer has to put 20% down to purchase with Conventional financing. Although, it may be common for 2nd and 3rd time homebuyers to invest 20% down or more (or have 20% equity or more on a refinance), many first time home buyers take advantage of lower down conventional financing options. With conventional financing there is No Mortgage Insurance requirement (PMI) for down payments of 20% or more.  The PMI does apply for down payments less than 20%, but the rate of the PMI will decrease as the borrower’s credit score increases and as the down payment increases from 3%, to 5%, to 10% to 15% down, to not being applicable with 20% down or more.

See example of a 20% Down Conventional Loan Estimate based on a $300,000 sales price

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Advantages of the Conventional Loan:

  1. The mortgage insurance for Conventional financing is not backed by any Federal Agency. Therefore, the mortgage insurance on a Conventional loan is called “Private Mortgage Insurance” or “PMI.” For higher credit score borrowers, the monthly PMI payment will usually be cheaper than the mortgage insurance for FHA Loans. Furthermore unlike the FHA & Rural Development Loan, the PMI eventually come off the mortgage (Homeowners Protection Act of 1998 V. Lending —HOPA (fdic.gov) ). As stated earlier, PMI is avoided altogether with down payments of 20% or more.

  2. It is a generally held belief that with competing offers to purchase, a seller may favor a conventional buyer’s offer over other types of financing considering all other terms being fairly equal.

Disadvantages of the Conventional Loan:

  1. Conventional mortgage rates and PMI rates are more sensitive to credit scoring than the government backed loans, such as FHA, USDA-Rural Development and VA Loans.  Thus, lower down Conventional/PMI buyers with credit scores under 680 are likely to have a higher monthly payment than they would with one of the government backed mortgages.

  2. Conventional mortgages are more difficult to get approved for than government backed mortgages.  Generally speaking, Conventional loans are tighter on credit history than government backed loans as well as debt-to-income ratios than FHA & VA loans.

FHA Loan

 

FHA Loans require a down payment of only 3.50% of the sales price. The guidelines for approving a FHA Loan and the mortgage insurance collected is by the Federal Housing Administration, which is part of the Department of Housing & Urban Development (HUD). This mortgage insurance, known as “MIP” (Mortgage Insurance Premium) is the same rate for every borrower, regardless of credit score. The MIP on a FHA loan is calculated by charging the buyer 1.75% of their base mortgage upfront which they can pay in cash at closing, but most elect to finance back into the mortgage. Additionally, the annual MIP is .85% of the base mortgage amount, and is divided out in escrow by adding it throughout 12 monthly house payments.

See example of a 3.50% Down, FHA Loan Estimate based on a $300,000 sales price

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Advantages of the FHA Loan:

  1. FHA mortgage rates are lower than Conventional rates since they are insured by a Federal agency.  Also, because the mortgage insurance (MIP) is fixed and not subject to credit scores, a 3.5% down FHA buyer with lower credit scores could have a significantly lower house payment than a low down Conventional/PMI buyer with the same credit scores.

  2. FHA is much more flexible in terms of approving prior blemished credit history, lower credit scores, and much higher debt-to-income ratios than conventional loans.

Disadvantages of the FHA Loan:  

  1. FHA loan are more expensive because of the upfront mortgage insurance which is 1.75% of the base mortgage.  For example, the $300,000 sales price FHA Loan Estimate example shows that the initial upfront mortgage insurance is $5,066 and is calculated in the total finance charges (as shown in Section B of the Loan Estimate).  This upfront mortgage insurance premium is paid to HUD from the closing, but most all borrowers will usually opt to finance back into the mortgage amount as shown in the FHA Loan Estimate.  Furthermore, the mortgage insurance that is included in the borrower’s monthly payment stays on for the life of a FHA loan.

  2. FHA Loans may have repairs required by the appraiser if they feel there is something that needs to be addressed to correct a safety or health hazard.  Because of this, and/or because a seller may feel that a conventional buyer is stronger, the FHA buyer may have a harder time competing against a conventional offer that is viewed as being otherwise fairly equal.

  3. For condos, FHA requires that the entire condo project be approved by the FHA.  The amount of condo projects that are FHA approved are very few in number.

USDA – Rural Development Loan

 

This is a Zero Down Loan, commonly referred to simply as the “RD Loan.”  The guidelines and mortgage insurance for this loan is governed by the United States Department of Agriculture (USDA).  The mortgage insurance is termed to be a “Guarantee Fee.”  The upfront Guarantee Fee is 1.00% of the base mortgage and can be paid in cash at closing, but is usually financed back into the loan.  The annual guarantee fee is .35% of the base mortgage amount, and is divided out in escrow by adding it throughout 12 monthly house payments.

See example of a Zero Down, USDA – Rural Development Loan Estimate based on a $300,000 sales price

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Advantages of the RD Loan

  1. The zero down feature is what makes this loan very popular and a huge advantage to many first time homebuyers.  Like all the other loan types, the RD loan allows the Seller to pay all closing costs which permits many buyers to purchase a home for very little money out of pocket with this loan.

  2. Like the FHA Loan, the RD Loan has very low interest rates – lower than Conventional Rates.  Additionally, the annual mortgage insurance (“Guarantee Fee”) on the RD Loan of .35% is quite low and can be 10% – 15% lower than PMI rates; even for high credit conventional borrowers.  The low interest rate & low mortgage insurance rate on a zero down RD Loan will account for a monthly payment that is lower than a monthly payment for a 3% down conventional loan or a 3.50% down FHA Loan.

Disadvantages of the RD Loan

  1. The RD Loan has some restrictions.  For one, the home must be located in an RD Eligible area.  Secondly, RD loans also have an income limit that is based on “household income.”  This means that all people to be living in the home will have to have their income counted against the income cap even if they are not part of the mortgage application.  To see RD eligible areas and income limits for a specific area, click here.  Eligibility (usda.gov)

  2. RD Loans will usually qualify borrowers for less home compared to other loan types because of the more conservative debt-to-income ratio requirements with this loan.

  3. RD Loans will usually take and extra 2-10 days to close compared to other loan types .  The extra time depends on the local RD’s current underwriting turn times since RD Loans have to be first approved by the individual lender, and then the local RD office.  Because of this, and because the RD appraiser may also require repairs, some sellers may not view a RD offer as favorable as a conventional offer.

VA Loans

The VA loan was designed to provide a benefit to our service men and women by offering VA guaranteed, Zero down mortgages and low mortgage insurance.  A Veteran may use their VA eligibility over and over to finance a new home as long as they continue to pay off their existing VA loan.  The VA’s version of mortgage insurance is called an upfront “Funding Fee.”  The amount of the Funding fee will vary depending on down payment, and whether the Veteran has utilized their VA eligibility before.  For first time use, the VA Funding Fee is 2.3% of the mortgage amount, and like the FHA & RD Loans, the Veteran will usually elect to finance the “Funding Fee” back into the loan.  Furthermore, the Veteran will usually be “Exempt” from having to pay the “Funding Fee” if they are receiving VA Disability payments.

See example of a Zero Down, VA Loan Estimate based on a $300,000 sales price

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Advantages of the VA Loan

  1. The zero down feature is what makes this loan very popular and a huge advantage to many Veterans.  Like all the other loan types, the VA loan allows the Seller to pay all closing costs which permits the Veteran to purchase a home for very little money out of pocket with this loan.  However, unlike the RD loan, the Veteran is not restricted to purchase in specific rural areas, nor does the VA loan have income limits.  Additionally, there are considerably more “VA Approved condos” then there are “FHA Approved Condos.”

  2. Like the FHA & RD Loans, the VA Loan has very low interest rates – lower than Conventional Rates.  However, there is NO Monthly mortgage insurance on a VA Loan – nota, zilch, none.  Because of this, and the lower interest rates, a Veteran may elect to finance their 2nd, 3rd, 4th homes with VA financing; even though, they may have a substantial down payment to work with.  In most scenarios, the VA Loan will provide the Veteran the best overall terms compared to any other type of financing.

Disadvantages of the VA Loan

  1. The VA buyer may have some of the same challenges as FHA & RD buyers in competing against Conventional offers if they are looking to finance zero down.

  2. The VA Loan requires a Co-Borrower to be married to the Veteran.  Thus, a Veteran cannot apply jointly with someone who is not their spouse.

Refinancing
These mortgage loan program comparisons were determined for the vantage point of a home buyer.  In some cases, these programs may have different guidelines or cost differences that would make one program better for a particular borrower when refinancing; although, another program might be better for them when purchasing.   When refinancing, it is also very important to know your options.  As always, I begin dialogue with each refinance customer by preparing them the Refinance Loan Estimates that are best suited for their situation, along with detailed Cost/Benefit analysis so that they can make sure they choose the best program for them, and whether refinancing is advantageous at all.

 

Together Naomi and I have over 60 years of combined experience to assist you. Please let us know how we may help you, or your friends, family or co-workers this year. We <3 Referrals!