When you’re in the market to buy a home, you most likely have a list of “must-haves” for the property and “nice-to-haves.” Although many people go into the home buying process knowing exactly what they want from a house, not as many people go into the process knowing what they want from their mortgage or what type of mortgage is right for them.
Different mortgages are designed to help people in different financial situations achieve the goal of homeownership. Your career, the amount you’ve saved as a down payment and the location of the property are all factors that can influence the mortgage types available to you. Learn more about each type of mortgage, so that you can pick the one that best meets your needs.
The simplest way to define a conventional mortgage is a home loan that isn’t backed or insured by the federal government. What that means is that there’s no safety net for a lender if a borrower has trouble making payments on the loan or stops making payments altogether.
For that reason, conventional mortgages typically have the strictest eligibility requirements, at least from a financial point of view. Often, people with credit scores over 740 are the most likely to get approval for a conventional mortgage. You can get approved for a conventional home loan if your credit score is as low as 620, but your interest rate will most likely be higher than the rate offered to a person with a score over 740.
The size of the down payment usually doesn’t affect your ability to qualify for a conventional loan, but a smaller down payment can mean a higher interest rate. A down payment of 20 percent is usually the standard amount, but it is possible to get a conventional loan with a down payment as low as three percent, and many homebuyers are making smaller down payments. According to data from the National Association of REALTORS®, more than 60 percent of first-time home buyers made a down payment of six percent or less during the last months of 2017.
Putting down less than 20 percent of the home’s value upfront typically means that you need to pay for private mortgage insurance, which gives the lender some reassurance that loan will be covered if you have trouble making payments. Once you’ve paid off enough of the mortgage to equal 20 percent of the home’s value, you can usually cancel the private mortgage insurance payments.
The amount of other debt you have, compared to your income, can also influence whether or not you can qualify for a conventional loan. Typically, your debt to income (DTI) ratio needs to be less than 50 percent to qualify for a conventional mortgage. Although some conventional home loan programs do accept DTI ratios as high as 50 percent, a ratio under 35 percent is usually preferred and will get you a better interest rate.
The price of the home you are considering buying can also influence whether a conventional mortgage is the right option for you. For a conventional mortgage to be considered a “conforming” loan, it can’t be worth more than $453,100 as of 2018. Mortgages made in “high cost of living areas” have a higher maximum loan amount for a conforming loan — $679,650 for 2018.
Higher value mortgages are available for more expensive properties, but they are considered non-conforming, or “jumbo” loans and have a different set of requirements, usually including a higher down payment amount.
While a conventional mortgage is not insured by the federal government, a Federal Housing Administration (FHA) loan is. The FHA loan program was created in the mid-1930s as a way to help people afford homeownership.
An FHA loan doesn’t come from the government itself but is instead made by an approved lender. With an FHA loan, your down payment can be as low as 3.5 percent. The minimum credit score accepted is usually 580, but your score can be as low as 510 if you put 10 percent down.
Although an FHA loan can make it possible for you to get a mortgage if you don’t qualify for a conventional loan, the program does come at a cost. The interest rate charged on an FHA loan is often slightly higher than the rate charged on a conventional mortgage. You also need to pay for mortgage insurance in two forms. The first is an upfront premium payment, usually worth 1.75 percent of the value of the loan. The second is a monthly mortgage insurance premium payment, usually between 0.45 and 1.05 percent of the loan value, depending on the length of the loan.
An FHA loan can make it easier for you to get a mortgage but can make owning a home more expensive in the long run when you add in the extra cost of mortgage insurance and a potentially higher interest rate.
To qualify for an FHA loan, the amount of your total mortgage payment and other housing-related costs such as property taxes and homeowners’ association fees can’t be more than 31 percent of your income. Your total debt to income ratio usually can’t be more than 43 percent of your income.
VA loans are another type of government-backed or government-insured home loan. VA loans have a few things in common with FHA loans, but also some pretty significant differences. One key difference is who is eligible for the loans.
VA loans are a program from the US Department of Veterans Affairs. They are available to people who are veterans, currently on active duty, members of the National Guard or Reserve and to surviving spouses.
Compared to FHA loans and conventional mortgages, VA loans offer multiple benefits to eligible veterans. One significant advantage of VA loans is that they don’t always require a down payment. A second considerable benefit of the loans is that there is no private mortgage insurance requirement.
VA loans do typically require a funding fee, the amount of which varies based on your down payment, type of loan, your military category and whether you’re buying your first home or not. Not every veteran has to pay the funding fee — it is typically waived for surviving spouses whose spouse died in service or from a service-related disability and for veterans who receive compensation for a service-related disability.
VA loans often require a bit more paperwork than other types of mortgages. To prove to the lender that you are a veteran or active duty service member who qualifies for a VA loan, you need a certificate of eligibility. Depending on your current service level, you’ll need to fill out DD Form 214 or present a signed statement of service when applying for the certificate of eligibility.
USDA Rural Development Loan
If you are interested in purchasing a home in a rural or suburban area, the United States Department of Agriculture (USDA) might have a mortgage program that is ideal for you. The USDA has two loan programs for people looking to buy a home. The Single Family Housing Guaranteed Loan Program is similar to FHA and VA loan programs in that an approved lender makes the loan to you, and the USDA backs it. Single Family Housing Direct Home Loans come straight from the USDA. The Guaranteed Loan Program is designed for applicants who earn a low to moderate income and the Direct Home Loan program is intended for applicants who earn a low or very low income. For example, the income limit for a family of two adults living in York County, Penn., is $85,450 for the Guaranteed Loan Program and $59,540 for the Direct Home Loan program.
Another important eligibility requirement for USDA home loans is the location of the property. For the direct loan program, the house typically needs to be located in a rural area with a population under 35,000. The USDA has a map that helps home buyers see if a property they are considering purchasing is in an eligible area.
When you apply for a USDA loan, the lender will look at your credit history and other debt. Usually, USDA loans are available to people with credit scores over 640 and with a debt to income ratio under 41 percent. USDA Direct loans typically don’t require a down payment and offer a lower than average interest rate. As of October 2018, the interest rate for Single Family Direct Loans was 3.75 percent.
Adjustable Rate Mortgage (ARM)
When you are shopping for a mortgage, it’s important not only to look at the amount of interest charged but also the type of interest charged. Mortgages often charge a fixed interest rate, which means that the interest stays the same for the entire term of the loan.
Some mortgages offer an adjustable interest rate. That means that the interest rate can rise or fall over the term of the mortgage, based on whether or not interest rates rise or fall in the market. When and how often an adjustable rate mortgage adjusts depends on the terms of the loan.
If you look at adjustable rate mortgages, you’re likely to see a fraction, for example, 5/1 or 7/3. The first number in the fraction, in this case, either the 5 or 7, refers to how long the initial interest rate is fixed. With a 5/1 ARM, you’ll pay a fixed rate for five years, with a 7/3 ARM, you’ll pay the initial fixed rate for seven years. The second number, in this case, either the 1 or the 3, refers to how frequently the rate adjusts after the initial term. In the case of the 5/1 ARM, your interest rate will adjust yearly. In the case of the 7/3 ARM, the rate adjusts every three years after the first seven years.
Getting an ARM is a bit like rolling the dice. Your monthly payments could fall after the initial period if interest rates drop. There’s also the chance that your monthly payment will increase after the initial period if rates climb. Many ARMs have rate caps, which help to keep your interest rate from rising too high.
203K Rehab Loan
If you’re not afraid of a little — or a lot — of DIY and are interested in purchasing a “fixer-upper,” the FHA 203k Rehabilitation loan program might be right for you. With a 203K loan, you can cover the cost of purchasing a house in need of some TLC and the cost of fixing up the property all in a single mortgage.
As with a standard FHA loan, you need to pay an upfront mortgage insurance premium and a monthly premium with a 203K loan. The down payment can be as low as 3.5 percent.
Physician Mortgage Loans
If you’re a doctor or about to complete medical school and become a doctor, a physician mortgage loan might be of interest to you. Designed for high-income earners who also have a considerable amount of debt from medical school, physician mortgages are often slightly more flexible than conventional loans. Many mortgages for physicians will accept an offer letter instead of income statements and some don’t require a down payment at all. A physician’s loan might also let you purchase a more expensive house — what would usually be considered a “jumbo” or non-conforming loan — without charging you a higher interest rate.
Which Mortgage Type Is Right for You?
Now that you have the basics of the different types of mortgages available, how do you go about picking the best one for you? In some cases, it’s a matter of process of elimination. If you’re not a veteran or a doctor, you can cross VA loans and physician loans off of the list right away. If you prefer to live in an urban area, you can eliminate USDA loans as well.
Next, it’s worth looking at your current financial situation and the typical price of homes in the area you’re hoping to buy. Do you have money set aside for a down payment? If so, how does it compare to the average or median cost of homes in your area? Will making a more substantial down payment prevent you from having enough savings set aside for emergencies or surprise expenses? If so, you might consider putting less down and paying private mortgage insurance.
Another thing to consider is your credit score. If you have excellent credit, you’re likely to get the best rate from a conventional mortgage. But if your score is around 600 or lower, the conventional mortgage route might be closed off to you at the moment. An FHA loan or another government-backed loan program might be a better option.
It’s also worth considering the overall cost of the loan. FHA loans tend to be less expensive than conventional loans up front, but because you often pay a slightly higher interest rate and mortgage insurance for the life of the loan, they can end up costing you more in the long run. It’s up to you to decide whether you’d rather pay less now and less on a monthly basis in exchange for paying more over the long run.
Let Century 21 Core Partners Help You Find Your Dream Home
If you are considering buying a home in York County, Penn., Century 21 Core Partners is here to help. We know the area, as well as parts of south-central Pennsylvania and northern Maryland, like no one else. We can help you find the home of your dreams and can help you choose the financing option that best meets your needs. Contact Century 21 Core Partners today to learn more.