You have learned to review your credit history, and set a down payment goal. After that, how do you determine which type of loan to apply? There are multiple types of mortgage loans. You have probably heard about some or all, but I will take this opportunity to break it down briefly. It is relevant to understand the types of mortgage loans. Doing so will help you to determine which one is better for you.
Because we wanted to pick the best mortgage loan for us, we decided to look into the benefits of each. We considered the Federal Housing Administration (FHA) loan program initially due to the low down payment. However, because of all the long term fees associated with it, we later declined it and went with a conventional mortgage loan.
TYPES OF MORTGAGE LOANS
So what is a conventional loan? It is the most common type of mortgage loan. A conventional loan is a type of loan that is not insured by the federal government. What does this mean? If a loan is not backed up by the federal government, it carries no guarantee from the lender when you default. Conventional loans have more flexibility, but it is difficult to qualify.
Since conventional loans are not government-backed loans, it is also riskier to the lender. So the lender typically charges Mortgage insurance if your down payment is below 20% of the price of the home. If you default on this particular loan, the lender can sell your home through short sales or through foreclosure to get their money back.
Depending on your financial history, you can negotiate the mortgage insurance. So instead of paying mortgage insurance until you have paid off 20% of the price of the home, the lender can offer you an upfront fee to get rid of the monthly mortgage insurance.
ADVANTAGES OF CONVENTIONAL MORTGAGE
- You can ask your lender to cancel the mortgage insurance once you have paid 20% of the home
- You can put as little as 3% down
- Overall borrowing cost is usually lower, even when the interest rate may be slightly higher than other loans
- You can use it for your primary home, investment property, or a second home
DISADVANTAGES OF CONVENTIONAL MORTGAGE
- A FICO credit score of at least 620 is required.
- A debt-to-income ratio of 45% to 50% is preferred.
- The lower the ratio, the better.
- You will pay mortgage insurance if the down payment is lower than 20%.
- It requires significant documentation such as assets, employment history, and down payment.
GOVERNMENT BACKED TYPES OF MORTGAGE LOANS.
There are three types of loans backed by government agencies. The three government agencies are the Federal Housing Administration (FHA loans), the US Department of Veterans Affairs (VA loans), and the US Department of Agriculture (USDA Loans). The government isn’t a mortgage lender, but they play a role in many Americans becoming homeowners.
FHA LOANS
FHA Loans are great programs for individuals with a credit score in the 500’s. With a credit score of 580, you can get a maximum of 3.5% financing. If your score is as low as 500, you can still get accepted into the program if you have at least a 10% down payment.
FHA loans have two types of insurance premiums. One of the insurance premiums, you pay upfront. The other is paid for the entire loan term if your down payment is lower than 10%. If you default on your loan, the government uses the insurance premium to pay your lender.
VA LOANS
As the name suggests, this type of loan is for veterans and active members of the US military and their families. There is no required down payment for VA loans. However, there is a funding fee between 1-3% of the sale price. If you cannot pay for this, the funding fee, as well as closing cost, can roll to your VA loan.
USDA LOANS
This is the type of loan that helps low-income borrowers to purchase rural homes, the home must be in a USDA eligible area and must meet a specified income limit. If you have low income, some USDA loans do not require a down payment.
The disadvantages of government-backed loans are the high overall borrowing costs and mandatory mortgage insurance premiums. An advantage is the credit score requirements. It is less, and you don’t need a high down payment.
MEDICAL PROFESSIONAL LOANS
The last loan type I want to talk about is Physician Mortgage Loan. I didn’t know there was such a loan. I came across this program while researching during our initial stages. These programs are great for medical professionals such as Medical Doctors, Dentists, and other eligible medical professionals to finance a house with little to no down payment.
As a pharmacist, I was looking for loan programs that fit my profession. There are two banks in the country for pharmacists with that program. You can put as little as 0 dollars as down payment, and no mortgage insurance. However, you need at least, a 700 credit score. We did not select the loan program because of the high-cost loan fees.
As a rule of thumb, your monthly mortgage should not be more than 25% of your monthly income. When lenders calculate your debt to income ratio, they look at your gross income. You may qualify for a 700K loan amount based on your gross income, but do not buy a house for 700K because you qualify without checking your finances.
We calculated our affordability based on our net income (the exact take-home pay). Even that, we still qualified for a higher amount than we purchased our home.
WHAT NEXT AFTER PICKING THE TYPE OF MORTGAGE LOANS
Once you research all the types of loans, what do you do next? You have to find the right mortgage lender. Finding the right lender is the same thing as going to the mall and selecting which type of designer clothes to buy.
With an established financial history, lenders want your business. I will discuss how to pick a lender on my next post. Subscribe below to receive notifications.
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