Buying a home can be a challenging process, yet is one that ultimately pays off when you move into a place you can truly call your own. But knowing which type of home loan you not only need, but also can afford, is part of the challenge.
As little education can go a long way when deciding which type of loan will work for you now and in the future, I've answered below the most frequently asked questions when it comes to home loans.
1. What are the primary sources of loans for home buyers?
Mortgage bankers, banks, and mortgage brokers all sell into FHA, Fannie Mae, Freddie Mac, and VA. They are agencies that purchase from, guarantee, or insure lenders to encourage home-ownership in the United States. There are many benefits for home buyers, but one key benefit these agencies offer is the opportunity to purchase a home with less than 20 percent down. All legal residents of the United States are eligible to qualify. Only U.S. military veterans are eligible to apply for VA loans, which offer a minimum of zero down within certain loan amounts. These agency loans meet most of all borrowers’ needs within “conforming” loan balances under $453,150.
2. What are popular types of home loans offered?
- 30-year fixed: A fixed-rate mortgage is a type of mortgage characterized by an interest rate that does not change over the life of the loan. A 30-year fixed is simply a fixed rate mortgage that lasts for 30 years. The 30-year fixed-rate mortgage loan is one of the most popular financing tools for home buyers today, accounting for more than 80 percent of home purchases. It is the “workhorse” of the lending industry, and it has been for a long time.
- Adjustable-rate mortgages (ARMs): ARMs still play an important role in making a purchase of a home more affordable. They offer lower interest rates when compared to a 30-year fixed, but only for a shorter fixed period of time–for example, a fixed period of 5, 7 or 10 years. There are different types of ARM categories: fully amortized; interest-only, and 40-year terms. Ask your loan officer which one best fits your needs.
- 203k loans: These basically are home-improvement loans that lend on the future value of the improved property. For example, if you’re buying a home for $500,000 and need improvements that will cost $50,000, the lender will base the loan amount on the future value of $550,000. This essentially allows the borrower to finance most of the cost of improvement. If you don’t have the money to renovate, this program can be a real benefit to creating your dream home.
- Reverse mortgages: These mortgages allow a homeowner to relinquish equity in their home in exchange for regular payments, typically to supplement retirement income. Unlike a traditional mortgage, which declines as you pay down the loan, a reverse mortgage balance rises over time as the interest on the loan accrues. It is important that a borrower seek out a reputable lender that specializes only in reverse mortgages. Danny also recommends having family members, typically the children, take part in the decision.
3. What does “conforming” mean as it relates to home loans?
A “conforming” loan is a mortgage loan that conforms to Fannie Mae and Freddie Mac guidelines. The most well-known guideline is the size of the loan, which as of 2018 is generally limited to $453,100 for single-family homes in the continental U.S. Some high-cost areas allow statutory “high balance” loans that vary from county to county. In Los Angeles and Orange counties, high-balance loan limits are $679,650, and in San Diego County it is $649,750. Loans that are greater than the conforming limits typically require loan-to-values of 80 percent, or 20 percent down.
4. What is your “debt-to-income ratio?”
Your debt-to-income ratio or DTI is just one factor that measures your “ability to repay” your mortgage by calculating your overall debt against your overall income. It is calculated by dividing all your monthly debt payments by your gross monthly income.
How closely do lenders look at the borrower’s debt-to-income ratio?
All four entities (Fannie Mae, Freddie Mac, VA, and FHA) allow approvals with debt-to-income ratios up to 49 percent, depending on several compensating factors. To calculate your debt-to-income ratio, lenders add up all your monthly debt payments and divide them by your gross monthly income, which is generally the amount of money you have earned before your taxes and other deductions are taken out.
5. What is mortgage insurance?
Mortgage insurance is an insurance policy that compensates lenders or investors for losses due to the default of a mortgage loan when the down payment is less than 20 percent. It does add cost to the loan and monthly payment, but it also allows a borrower to put less money down.
What if you’re self-employed and want a home loan?
There is no shortage of loan programs for self-employed borrowers. The rules for qualifying are the same as for non-self-employed borrowers. The criteria or requirement are the same: Does the borrower have the “ability to repay” the mortgage? There are also a few unique niche programs that cater to those borrowers who may not want to submit their tax returns.
6. Is it possible to stay in your home before buying the next one you want?
Yes. Again, does the borrower have the “ability to repay” the mortgage(s)? There are loan programs that make it easier to “eliminate” the departing-residence payment. Options range from legitimately renting the departing residence to cross-collateralizing both properties. Programs like these can help those who want to purchase their new home before selling their existing home.
7. What is the difference between loan pre-approvals vs. pre-qualifying?
Unfortunately, the Consumer Financial Protection Bureau has not defined what a pre-qualification or a pre-approval is. Regardless of what we call it, it is important that a loan officer complete a detailed analysis of all the factors that can determine if a borrower has the “ability to repay” the mortgage. Some of the documentation the loan officer needs to do an analysis include, but are not limited to, reviewing your income documentation, asset statements, and credit.