Recently, I’ve been spending more time than I care to admit with mortgage brokers. First my wife and I refinanced our home to take advantage of the low mortgage rates (we got 4.825% fixed for 30 years on a super conforming loan). And then I refinanced one of my investment properties.
During this refi bonanza, I spent some time talking to the mortgage brokers about the different types of mortgages. Particularly if you are a first-time homebuyer, understanding your home loan options can mean the difference between qualifying for your first home or continuing to rent. So we’re going to take a look at the three types of loans available to first-time homebuyers: conventional loans, Federal Housing Administration (FHA) loans, and Veterans Administration (VA) loans.
A conventional mortgage is the most common type of home loan. These loans have terms and conditions that meet the underwriting requirements set by Fannie Mae and Freddie Mac. As a result, a conventional loan requires a certain down payment and debt-to-equity ratio. Conventional mortgages can be either fixed rate or variable rate loans. Although other mortgage terms are available, conventional mortgages are issued over a period of 15 or 30 years.
Conventional loans can be conforming, super-conforming, or non-conforming, according to Fannie Mae. The conforming loan limit for a single family home is $417,000, and $729,750 for a super-conforming loan in certain high cost areas of the country. Loans higher than these amounts are non-conforming. All other things being equal, the interest rate on a conforming loan is lower than a super-confirming loan, and a non-conforming loan carries the highest rates.
Federal Housing Administration Loans
An FHA loan allows you to purchase a home with a smaller down payment. The FHA accomplishes this by requiring borrowers to purchase mortgage insurance. As a result, FHA borrowers are eligible for up to 96.5 percent financing. Only homes with between one and four units qualify. To get an FHA loan, a borrower must meet eligibility standards determined by the FHA.
The mortgage insurance, however, isn’t cheap. FHA-backed loans require borrowers to pay an upfront and annual premium on mortgage insurance to protect the lender against default. While the cost of mortgage insurance varies based on the amount of the down payment and loan term, you can expect the insurance to cost about 1% of the loan balance each year. You can get more details on the cost at the FHA website.
There is good news when it comes to mortgage insurance–it eventually goes away. FHA’s insurance premiums automatically terminate when these conditions occur:
- For mortgages with terms 15 years and less and with Loan to Value ratios 90 percent and greater, annual premiums will be canceled when the Loan to Value ratio reaches 78 percent regardless of the amount of time the mortgagor has paid the premiums.
- For mortgages with terms more than 15 years, the annual mortgage insurance premiums will be canceled when the Loan to Value ratio reaches 78 percent, provided the mortgagor has paid the annual premium for at least 5 years.
- Mortgages with terms 15 years and less and with loan to value ratios of 89.99 percent and less will not be charged annual mortgage insurance premiums.
There are loan limits for FHA mortgage products. These limits vary by state and county. As an example, here are the loan limits in five cities in Virginia:
You can find information on FHA loan limits for all states here.
Veterans Administration Loans
VA loans are a special type of loan guarantee afforded as a benefit to veterans of the armed services. Veterans who qualify for VA loans are able to purchase a home without a down payment (see service requirements to qualify for a VA loan here). Those eligible include:
- Active duty personnel
- Certain reservists and National Guard members
- Surviving spouses of persons who die on active duty or die as a result of service-connected disabilities
- Certain spouses of active duty personnel who are (a) missing in action, (b) captured in line of duty by a hostile force, or (c) forcibly detained by a foreign government or power
The VA guarantees the home without an added insurance premium. VA loans can be used on single family homes, approved townhouses or condominiums, to build a new home, or to buy and remodel a home. VA loans can be structured in 15, 20, 25 or 30 year terms with fixed interest rates. Veterans can qualify for a zero-down loan up to the amount of $417,000.
VA loans offer several advantages over conventional loans:
- You can buy a home without a down payment – as long as the sales price doesn’t exceed the appraised value. (Of course, you have to qualify in terms of income and credit.)
- You won’t need to buy private mortgage insurance.
- VA rules limit the amount you can be charged for closing costs.
- Closing costs may be paid by the seller. (You should keep this in mind when negotiating the sales price.)
- The lender can’t charge you a penalty fee if you pay the loan off early.
- VA may be able to provide you some assistance if you run into difficulty making payments.
No matter which loan you choose, make sure you do your homework and do a hard target search for the best mortgage rates available.