Which Mortgage Type?
Knowing what mortgage type is best for you can be somewhat of a doozy. For this reason, it should in your best interest to find a reputable mortgage lender. This will allow you to be consulted by an expert while finding out what home loan is best.
Before continuing, I must make a disclaimer. My intent with this article is to briefly describe each type of loan while giving my opinions. I am a Realtor, and I do not proclaim myself to be a mortgage expert whatsoever.
FHA Home Loan
FHA home loans are government-assisted and self-insured. Generally, a 3.5% down payment is needed, and an approved lender may require you to have a credit score of at least 580. However, as I will say many times throughout this article, the credit score requirements will vary per lender. But if your credit score happens to be less than that, you might have to put down 10% instead. Below are the other factors to consider for an FHA loan.
You must have a steady stream of income, and the property you’re buying must be your primary home. Generally speaking, your debt-to-income ratio should not exceed 43%.
If you do not have a credit history, your lender will have to obtain a non-traditional merged credit report. Otherwise, you will somehow have to develop a track record of maintaining good credit.
On the contrary, having a past of bankruptcy does not disqualify you from obtaining an FHA loan. But what about Chapter-7 specifically? In that case, at least a span of two-years has to pass along with restoring your credit. You must have a solid year’s worth of mortgage payments in reserves.
Furthermore, having a history of foreclosing on a home will not hinder you from obtaining an FHA loan, but that will depend on the circumstances. All of your judgments must be settled or repaid before moving forward. This type of mortgage is usually best for first-time homebuyers.
USDA Home Loan
A USDA home loan program allows low-to-modest income homebuyers in rural areas to afford decent-quality housing. This type of home loan is guaranteed and backed by the government. No down payment is usually needed. To begin the home loan process, you will first need to apply for their Single-Family Housing Guaranteed Loan Program, and your median household income cannot exceed 115%.
Similar to an FHA loan, the home you’re buying must be your primary residence. Their debt-to-income ratio is written as 29/41. The first number is the monthly housing debt to be paid out of your gross monthly income. Then the second number is your overall debt-to-income ratio. Although the USDA doesn’t have any credit score requirements, a lender offers this type of loan will.
One of the significant benefits of this mortgage type is that you could take advantage of their home repair loans and grants. Thus, allowing you to make any repairs necessary for your home.
VA Home Loan
The Veteran Affairs home loan program, was created in 1944 as a part of the original Servicemen’s Readjustment Act, otherwise known as the GI Bill of Rights. Franklin D. Roosevelt, the 32nd President of The United States, was the one who signed this program into law. Below are the four loan types offered by the VA.
- Purchase Loan
- Native American Direct Loan
- Interest Rate Reduction Refinance Loan (IRRRL)
- cash-out refinance loan.
VA loans are government-backed and are only available to veterans, active servicemen, and surviving spouses. There is also no requirement to make a down payment. The eligibility requirements will vary based upon the amount of time you have served. Your debt-to-income should not surpass 41% to qualify, and even though there are no credit score requirements, VA approved lenders will have their own set of guidelines.
Jumbo loans are for homes that are too expensive for conventional conforming home loans. If you’re looking to buy a single-family home, lenders will typically want you to put at least 20% down. As far as credit scores are concerned, they can range from 300 to 850, but that will depend on the lender.
All in all, you should have at least a credit score of 700 to obtain a mortgage for a one or two-unit property, and your limit will top out at $1,000,000. But if you’re a home buyer looking to borrow $1,500,000, you will then need a credit score of at least 720 instead.
If that’s still not enough and you’re seeking to borrow $2,000,000, then a score of 740 is needed. Well, what if you’re thinking about buying a second home?
As long as your credit score is within 720 to 740, you shouldn’t have a problem, but as said before, the requirements will vary per lender. Lastly, your debt-to-income ratio should generally be more than 50%. With this in mind, this type of mortgage would be ideal if you’re a wealthy homebuyer.
Reverse Mortgage Type
A reverse mortgage can allow a homeowner who is 62 and older to convert a part of their home’s equity into cash, but without selling or repaying the amount every month. In contrast, it’s like your lender is sending you a cash advance each month.
If you’re 62 or older, you may choose to do this if you need extra income to pay any bills that may have you running thin. However, you must have at least 50% equity in your home, and the older you are, the more funding you can obtain. The property you’re using a reverse mortgage against must be your primary residence during the life of the loan.
Who Is a Reverse Mortgage Best for?
If you’re a 62 or older homeowner and need added income to help with certain living expenses, this could be for you. But please make sure to speak to a mortgage professional first.
Adjustable-Rate Mortgage (ARM)
An adjustable-rate mortgage, also known as an ARM loan, is the exact opposite of a fixed-rate mortgage. Instead, your interest rate will be fixed for a set period and then change after that period is up. In other words, your interest rate will go from briefly fixed to henceforth evolving with the market conditions each year.
As confusing as this may sound to some of you, it’s actually pretty easy to understand. For instance, let’s say you’ve obtained an ARM loan with a 5 to 1 ratio. The “5” stands for the amount of time, as in years, your interest rate will be fixed. Then after those 5 years is up, your interest rate will henceforth change once per year, which is what the “1” stands for.
You can put down as little as 5%, but you will need to buy mortgage insurance. On the other hand, if you’re able to put down 20%, mortgage insurance will not be required. Although this type of mortgage has many benefits, it certainly isn’t for everyone.
Interest-Only Mortgage Type
During the Great Recession, interest-only loans were infamous. The reason being is because this type of mortgage played a significant role in causing the financial meltdown of 2008.
Thankfully, lending standards are a lot stricter than they were. Most of today’s mortgage lenders are doing what they can to prevent another crisis from happening. Before, lenders were marketing interest-only mortgages to home buyers as “financial candy,” so to speak.
I say this because they attracted naïve and financially illiterate home buyers. Then, of course, people began buying homes they really couldn’t afford in the long run.
You see, with an interest-only mortgage, you’re only paying on the interest each month for a set period. This period is usually about three to ten years. After that period has passed, the loan’s actual balance is attached to the interest each month. Thus, turning it into a regular monthly mortgage payment.
The Aftermath of Using This Type of Mortgage…
Based on the results, a vast amount of people could not produce the funds needed to pay their mortgage note each month once it amortized. Forthwith causing a massive number of homes to go into foreclosure.
Given these points, these relaxed lending standards were a big reason the housing market was so crazy pre-2008. Any human being with a pulse could qualify for this type of loan. A loan of which many homebuyers clearly had no business obtaining.
Nowadays, you will have to put down at least 20% of the purchase price for this type of loan. Credit score requirements will vary per lender, but you will more than likely need a score of at least 720. Furthermore, debt-to-income standards could range from 35% to 43%.
Your income will be assessed against the loan’s entire balance in today’s world of mortgage lending. Whereas before, your income would only be evaluated against the interest-only payment amount. The terms for an interest-only mortgage generally last three to ten years until the principal is applied.
Unlike traditional mortgage loans, a balloon loan does not amortize over time. For example, let’s say you have 5 years until the remaining balance is due. After year 5 has arrived, that is the end of your loan term. Now you have to repay the remaining amount owed on loan as a large lump sum. In other words, the payment due will “balloon.” Hence the name, balloon loan.
Your “balloon payment” will henceforth become equal to the remaining balance of a typical 30-year mortgage. Now that you’ve paid 5-years’ worth, the outstanding balance will match the remaining 25-years of your loan. However, if this wouldn’t be doable for you, a “reset” option is available, which will automatically recalculate the mortgage amount at the then-current interest rate.
Just like many homeowners, you might be planning to refinance into more of a traditional mortgage at some point. With this in mind, it’s recommended that you should try to refinance into a long-term loan as soon as you can.
Nevertheless, I recommend that you be careful with a balloon loan. Especially if your credit score has taken a big hit. A falling credit score will cause good loan options to become inaccessible to you. Thus, after a while, your only choice could be foreclosure. Many balloon loan borrowers found themselves in that kind of situation during the financial crisis of 2008.
Last but not least are conventional loans. Unlike FHA, VA, and USDA loans, this type of mortgage is not insured or guaranteed by the government. Instead, they are backed by private lenders, and mortgage insurance is to be paid for by the borrower.
Debt-to-income ratio standards are usually no greater than 43%, and a credit score of at least 720 is generally required by lenders. Although mortgage lenders will typically want at least a 3% down payment, you won’t need to buy mortgage insurance if you’re able to put 20% down. Lastly, you can only use a conventional loan against a property that will be your primary residence.