Different Loan Types
Mortgages can be defined as either government-backed or conventional. Government agencies like the Federal Housing Administration (FHA) and the Department of Veterans Affairs (VA) insure home loans, which are made by private lenders. This insurance is paid for by fees collected from mortgage borrowers. The US Department of Agriculture (USDA) loans money to lower-income borrowers through its Direct Housing Program. It also guarantees loans made by private lenders through its Guaranteed Housing Loans program. This backing is paid for by borrowers.
Mortgages not guaranteed or insured by these agencies are known as conventional home loans. They include:
- Conforming loans
- Non-conforming loans
- Jumbo loans
- Portfolio loans
- Sub-prime loans
Conventional Loans Explained
About half of all conventional loans are called “conforming” mortgages, because they conform to guidelines established by Fannie Mae and Freddie Mac. These two government-sponsored enterprises (GSEs) buy mortgages from lenders and sell them to investors. Their purpose is to make mortgages more widely available. All conforming mortgages are also conventional mortgages.
Loans that do not conform to GSE guidelines are referred to as “non-conforming” home loans. Non-conforming loans that are larger than loan limits set by the GSEs are often referred to as “jumbo” mortgages. All non-conforming mortgages are also conventional mortgages.
Conventional loans held by mortgage lenders on their own books are called “portfolio” loans. Because lenders can set their own guidelines for these loans and do not sell them to investors, these products may have features that other mortgages do not. For example, a portfolio lender might allow a borrower to use investments like stocks and bonds as security for a mortgage for which she would not otherwise qualify.
Conventional home loans marketed to borrowers with low credit scores are called sub-prime mortgages. They typically come with high interest rates and fees. The government has created special rules covering the sale of such products, but they are not government-backed — they are conventional loans.
For many Americans who consider owning a home as part of the quintessential American Dream, the FHA enables them to accomplish their goals of home ownership with very little money down. In fact, many borrowers can get FHA loans with as little as 3.5% down. FHA loans are insured by the federal government with mortgage insurance premiums (FHA MIP) paid for by borrowers.
Why was the FHA Created?
In 1934, when the FHA was created, the U.S. housing economy desperately needed to improve. According to the U.S. Department of Federal Housing and Urban Development (HUD), which the FHA became a part of in 1965, most people were renters during the 1930’s.
At that time, it was very hard to get a mortgage, and the typical mortgage terms were unreachable for many people. In fact, according to HUD, most mortgages “were limited to 50 percent of the property’s market value, with a repayment schedule spread over three to five years and ending with a balloon payment.”
Since people in the 1930’s were just coming out of the Great Depression, the FHA made a big impact on the housing economy in the United States. In the 1940’s, they were able to help military personnel get housing loans and secured housing for the elderly.
Essentially, because the FHA exists, lenders don’t have to worry about riskier borrowers defaulting on their loans. If borrowers do default on the loan, the FHA insurance would cover any losses. It also helps borrowers who are getting back on their feet with lower credit scores or a history of bankruptcy to have a chance to improve their situations and make their dreams of home ownership a reality.
What are the Types of Loans the FHA Offers?
The FHA offers several different types of loans. Below are three of the most common ones.
A fixed rate mortgage is just as the name implies. When you sign the mortgage paperwork, you agree to an interest rate that won’t change. You can also choose many different lengths of a mortgage, from a 10 year to a 30-year term.
Adjustable rate mortgages have interest rates that will change. However, with this type of mortgage, your interest rate doesn’t necessarily have to change every single year. You can get a 5/1 mortgage where your interest rate is fixed for 5 years and then the rate adjusts every year thereafter. There is also a 7/1 adjustable rate mortgage and even a 10/1, too. This can be a good option if you know you will be moving before your rate starts to adjust.
Home Equity Conversion Mortgage
The more common name for this type of FHA mortgage is a reverse mortgage. These are for seniors over 62 years old who own their home entirely or have a lot of equity. Essentially, you borrow against the equity in your home in order to receive payments or a line of credit. Many people do this when they need additional money after they have retired.
While the types of mortgage loans mentioned above are the most popular, there are other types of FHA loans including the FHA Graduated Payment Mortgage (GPM), FHA’s Growing Equity Mortgage (GEM), and FHA’s Energy Efficient Mortgage Program.
What Impact has the FHA had on Home Buyers?
The FHA, as previously stated, has made it possible for millions of people to become homeowners. In fact, according to HUD, “The FHA and HUD have insured over 34 million home mortgages and 47,205 multifamily project mortgages since 1934.”
It’s important to note that FHA loans are typically more expensive than traditional mortgages in the long run. For example, homeowners who finance more than 80% of their home loans have to pay Private Mortgage Insurance on top of their regular mortgage payments. On the other hand, those who get FHA loans can typically qualify for a mortgage with as little as 3.5% down on their home and they don’t even have to put down their own money. The money can be given to the homebuyer in the form of a gift or grant that can then be applied to the down payment of the home.
For most borrowers, high down payment amounts and poor credit are what holds them back from becoming homeowners. The FHA makes it possible for people who don’t meet these qualifications to get a home loan because lenders are insured by the FHA and don’t have to worry as much about losing money if a borrower defaults.
A VA loan is a mortgage loan made by an approved lender and guaranteed by the Department of Veterans Affairs. They are made available to eligible veterans, those currently serving in the military, and, in some case, their spouses.
VA Loan Explained
A VA loan differs somewhat from a standard mortgage. Even though it is provided through a private lender, the federal government guarantees a portion of the principal. That means that the Department of Veterans Affairs backs the loan, so if the borrower defaults on it, the lender is protected. Borrowers who are eligible for a VA loan are permitted to have a small, or sometimes non-existent, down payment and still get a mortgage. This is the biggest advantage of a VA loan. Be sure to ask your lender what its down payment requirements are when requesting a VA loan.
Some of the requirements for a VA loan are standard, as with any loan: good credit, enough funds for payments, etc. For example, there is a minimum credit score requirement, as well as income requirements for getting a VA loan. You must also be eligible though your affiliation with the military. To see a full list of eligibility requirements, visit the Department of Veterans Affairs website. This site also answers many specific questions about the program.
Certificate of Eligibility
When requesting a VA loan, you need a certificate of eligibility to show the lender. You can get this certificate through the Department of Veterans Affairs. Upon providing it to the lender, the lender can then help you.
What is a Reverse Mortgage?
A reverse mortgage is a type of loan available to homeowners age 62 and older. Instead of purchasing a home and taking out a traditional mortgage, a reverse mortgage allows homeowners to convert the equity in their home into cash.
Reverse mortgages were designed to give seniors an extra source of income to rely on for monthly expenses, medical bills, or whatever they please. There are no limitations on how funds from a reverse mortgage can be used.
How to Access Funds from a Reverse Mortgage
Reverse mortgage funds can be dispersed in three ways: either as monthly installments, a line of credit or one lump sum. Borrowers can also receive their funds through a combination of monthly installments and a line of credit. With the line of credit, you are only charged interest on the funds that you use, similar to a home equity line of credit or a credit card.
The amount of money you can access depends on how much equity you have available in your home, your age and your interest rate. During the first year of your reverse mortgage loan, you can take out 60 percent of those funds.
Paying Back a Reverse Mortgage
Since most reverse mortgages are backed by the Federal Housing Administration, or FHA, the loan is not due back until the borrower either moves out of the home, sells the home or passes. Borrowers are required to keep up with the maintenance of the home and pay their property and homeowner’s insurance. If they fail to do so, the loan can become due immediately.
If you pay back the loan by selling your home, any leftover money will go to you or your heirs.
Factors to Consider Before Applying for a Reverse Mortgage
Reverse mortgages typically come with a higher interest rate than a traditional mortgage. As with any financial decision, it’s important to do your research and decide what would be the best option for your personal situation. A few things to consider include:
How you’ll use the money.
Do you need an extra source of income every month, or are you just wanting to go on an exotic vacation? Depending on your need, there could be a better solution, such as a home equity loan or personal loan.
If you plan to leave your home to your heirs.
If you want to leave your home to your children, a reverse mortgage could jeopardize that. When you pass, you’ll have to pay back the loan either by selling it or having your heirs pay it back.
Where your partner will live if you pass first.
If you want your partner to be able to continue living in the home if you were to pass first, make sure to have them as a co-borrower on the reverse mortgage. This will allow your partner to continue living in the home until he or she passes, too.