Which do you select first: the loan program or the lender? In most cases, it’s best to decide on the type of loan that will best meet your financial goals, then find a reputable lender who can deliver that option to you at a competitive cost.
If you’re looking for a very new type of loan option, or a relatively obscure one, you may only have a few lenders to choose from. For a more “main-stream” mortgage program, you’ll have lots of lender choices.
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Mortgage Terminology |
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Loan programs fall into all kinds of categories, and some have several different names. It’s helpful to understand some basic terminology before begin to consider today’s abundant choices.
- Conventional Vs. non-conventional. Conventional loans are simply loans that are not insured by the Federal Housing Administration (FHA) or guaranteed by the Department of Veterans Affairs (VA). The non-conventional financing backed by the FHA and VA offers lower down payments and special terms to those who qualify.
- Conforming Vs. non-conforming. Often confused with the above terms, conforming really refers to whether a loan meets certain guidelines established by the Federal National Mortgage Association (FNMA; “Fannie Mae”), and the Federal Home Loan Mortgage Corporation (FHLMC; “Freddie Mac”). These guidelines apply to loan limits, the borrower’s credit history and type of income, and characteristics of the property being financed, among other things. If all the guidelines are met, the loan “conforms” and qualifies for a lower interest rate and lower costs compared with non-conforming loans that pose a higher risk to lenders.
- Jumbo loans. Mortgage loans higher than the conforming loan limits are “jumbos,” which carry higher interest rates. (Note: Loan limits may be changed annually; ask us or a mortgage lender for the current limits in the area you are interested in.) Jumbo loans are non-conforming loans because they exceed loan limits set by Fannie Mae/Freddie Mac. As of this writing, the general conforming loan limit for a single-family home in the contiguous United States, District of Columbia and Puerto Rico is set at $417,000. However, for one-unit properties in high-cost areas, the maximum limit is $729,750 for loans originated on or before September 30, 2011. After that date the maximum limit is set at $625,500. High-cost-area loan limits vary by geographic location. The limit for a particular area is calculated as 115% of the previous year’s median home price for that area, up to the current maximum loan limit (depending on the date of loan origination). Loans on single-family homes in Alaska, Guam, Hawaii and the U.S. Virgin Islands use the maximum high-cost-area loan limits.
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Common Loan Options |
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It seems every couple of months, a new approach to home financing is introduced to the market. Generally, though, you’ll choose from some variety of the following mortgage loan types:
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Fixed-rate mortgage. The interest rate on these loans remains the same for the life of the loan, as does the monthly payment.
The 30-year fixed-rate mortgage is by far the most commonly chosen loan type because its low monthly payments allow buyers to purchase more home for their income. Even though the long-term interest expense is high (compared with shorter-term loans), the early years of a 30-year loan reward borrowers with a sizable mortgage-interest tax deduction. For a conventional loan, if you make less than the standard 20% down payment, you will likely have to pay for private mortgage insurance (PMI), until your equity in the home reaches 20%.
Also available: 20-year and 15-year fixed-rate mortgages offering lower interest rates and faster payoffs, but higher payments. Both FHA and VA offer 30-year and 15-year loans, with low or no down payment required.
Fixed rates are a good choice when rates have been stabilized at a relatively low level or when they’re beginning to rise.
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Adjustable-rate mortgage (ARM). These loans start at a rate that’s usually lower (sometimes substantially) than fixed rates. However, the rate on an ARM will change according to a predetermined formula based on some financial market index (e.g., Treasury bills). The rate changes at certain intervals (after 1, 3, 5, 7 or 10 years, on a set schedule, then annually). As the rate changes, so will the monthly payment and interest costs of the loan. ARMs have “caps” that limit how much the rate can adjust annually and over the life of the loan.
ARMS are a good choice when rates have been relatively high or when they are dropping. An ARM may also be a good choice if you don’t expect to keep the loan for more than a few years — you can benefit from the low initial rate (and payments) before it adjusts upwards.
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Two-step mortgage. A 30-year loan that starts at a lower-than-fixed rate and adjusts once, to whatever the fixed market rate is at the 5-, 7- or 10-year mark. A 7/23 loan, for example, is a two-step mortgage with a rate adjustment at the 7-year mark.
Like an ARM, a two-step loan offers the benefit of a low initial rate, and may be a good choice for borrowers who do not expect to hold the loan full term or who know their income will increase to cover larger payments (in the event the adjusted rate is significantly higher).
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Assumable mortgage. FHA, VA and some ARM loans can be assumed by a new buyer with the approval of the lender. In this case, the buyer agrees to pay off the seller’s equity with a down payment, then takes over responsibility for the seller’s loan at the interest rate it was originally issued with. Buyers may arrange for a second mortgage (sometimes offered by the seller) to help cover the down payment, which may be substantially higher than 20% if the seller has owned the home for a number of years.
Assuming a loan is a good choice if its interest rate is lower than current market rates or if your credit isn’t quite up to snuff for getting a new loan. In addition, you may save on closing costs compared with a new loan.
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Balloon mortgage. Offered by some lenders, balloon mortgages are also offered by some sellers who agree to “take back” a loan from their buyers. The borrowed amount is amortized over a 30-year period, keeping payments relatively low for, say, 5 or 7 years, at which point the balance of the loan is due in a lump sum.
You may want to choose a balloon mortgage if you expect a large sum of cash to come your way by the end of the mortgage term, or if you expect to be able to refinance at a reasonable rate by that time.
- Built-up mortgage. Cash-poor buyers can get into a home without paying private mortgage insurance (PMI) with a built-up mortgage. These are loans that involve two trusts and a smaller-than-20% down payment. For example, an 80-10-10 loan requires a 10% cash down payment with a 10% second trust to subsidize the 80% first mortgage. There are even 80-15-5 loans where the buyer only needs a 5% down payment. These mortgage programs help save buyers money each month by avoiding PMI.
- Other mortgage choices. You may encounter a variety of other loan choices that could meet your needs. Be sure to get a detailed explanation of terms and obligations before making your final decision. Remember, rates aren’t everything; compare the total costs of the loan, including discount points and various lender’s fees, before making your final decision.
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Picking A Lender |
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When looking for a lender, there are several non-financial characteristics your should consider:
- The lender’s track record of closing loans, providing professional service and delivering the loan within the good-faith estimate can be much more valuable than a low interest rate.
- If you’re looking at a special form of financing, find out how many of that type of “non-conventional” loan the lender has brokered. Not all loan officers work with VA loans, or construction loans or wrap-around loans. These are specialty programs where experience comes at a price.
- Consider the depth of a lender’s program offerings. If for some reason your first mortgage choice falls through, you’ll need more than a one-program lender to give you options. The idea is to avoid having to transfer your loan from one lender to another because the first lender doesn’t work out.
Closing the loan is much more important than finding the lowest cost. It doesn’t matter how much you “would have” saved on a mortgage if it never goes to settlement because the lender couldn’t meet your needs.
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