Did you know there was a choice? Did you know that an FHA loan is not just a single loan program but actually several? Sometimes thinking about which loan program is best for you, it can get a little complicated. Mortgage programs aren’t designed to be complicated but new programs can come about to address a specific need or market trend. But at first glance, you will immediately notice there’s a lot more out there than just a 30 year fixed rate loan. Your loan officer that will be your main source of assistance to help you along on your home buying journey. Broken down into categories, the fog begins to lift and you can easily decide which choice to make.
Conventional vs. Government
Conventional loans are the most common. In fact, close to two out of three existing mortgages today are conventional types. Conventional loans are those where the lender assumes the risk of approving a mortgage application. Should the loan ever go into default the lender takes the loss. With a government loan, the lender is compensated for all or part of the loss should the loan go into default. Of these conventional loans, the most common are those using Freddie Mac or Fannie Mae standards.
Government loans mean there is a government-backed guarantee associated with the mortgage. It doesn’t mean any branch or government department makes the loan but the specific government agency provides guidelines lenders follow. As long as the lender follows the proper guidelines when approving a loan and the loan goes into default, the lender is compensated.
This compensation is financed by various forms of mortgage insurance. Mortgage insurance is an insurance policy and is the source of the guarantee to the lender. Borrowers who take out government-backed loans pay for a mortgage insurance premium. These premiums are rolled into the loan amount and there may also be an annual premium paid in monthly installments, as is the case with FHA and USDA loans. The guarantee shouldn’t be confused to mean the applicant is guaranteed a loan approval. The applicants must still qualify based upon standard approval guidelines such as sufficient income, credit, cash to close, among others things.
Whether a conventional or a government loan is best for your situation, that’s something to discuss with your loan officer. If you have a down payment of say 10-20% or more, then a conventional mortgage is probably your better choice. Government loans still require a mortgage insurance payment regardless of the size of your down payment. But if you want to close with as little strain on your bank account as possible then a government loan is probably your best choice.
There are three government loans, FHA, VA and USDA. VA loans are only for those who have served in the military, are active duty with six months of service, National Guard and Armed Forces Reserve members with six years or more of service and un-remarried surviving spouses of those who have died while in service or as a result of a service related injury. USDA loans require the property be located in a rural area and the applicant’s income cannot exceed 115% of the median income for the area. If neither of these fit your situation, then the FHA loan is available.
Okay, so you’ve decided on an FHA loan, which one? That’s right, there are still more choices to make beyond conventional versus government and which government program is best for you. You’ll need to decide whether or not you want a fixed rate loan or an adjustable rate mortgage. Adjustable rate mortgages provide lower start rates compared to available fixed-rate loans. The appeal of an adjustable rate mortgage, or ARM, is the lower rate. But as the name implies, it can and will adjust at some point in the future.
ARMs can adjust based upon a predetermined list of rules spelled out specifically in the note. When an ARM gets ready to adjust, the base index is noted. A common index might be a 1-year Treasury Bill or what’s known today as a Constant Maturity Treasury, or CMT. The next component is the margin. This is the amount added to the index to come up with the new rate. If the index is 2.00 and the margin is 2.00, the new rate until the next adjustment is 4.000%.
Most FHA ARMs today are offered in the form of a hybrid which provides an initial fixed rate term before turning into a loan that can adjust annually or once every six months, whatever the note says. Fixed rate terms for a hybrid can be for three or five years and are listed as 3/1 and 5/1 loans. Other terms may also be available. If someone plans to buy a property yet keep it for a relatively shorter term, such as five or seven years, then an FHA 5/1 or 7/1 loan might be better because the rates will be slightly lower than a corresponding fixed.
You’ll also need to select how long you want the term to be. Loan programs can come in terms ranging from 10 to 30 years in five year increments. Shorter terms mean higher payments but lower lifetime interest. Conversely, longer terms provide lower payments but more interest paid to the lender over the life of the loan.
Finally, once you’ve decided on the type of loan and the term, you’ll need to select an interest rate. There are multiple interest rate options for the very same loan program. These rates are offered in 1/8th increments. You can pay discount points, or “points” to get a lower rate or you can lower the overall cost of your mortgage with a slightly higher rate. Rate choices should be discussed with your loan officer. Your loan officer will provide you with different monthly payments based on whether or not points are needed. Once you’re at this stage, your FHA loan is set.
Please call us today at the number above to learn more about any of the government or conventional loan options mentioned.