An introduction to loan products for buying real estate
We are picking up our series “Understanding Financing” with today’s post, where we will look at the main loan products that most buyers use in the purchase of real estate. There are a lot of products on the market, various criteria to qualify for each, and different requirements from different lenders. My goal today is to give you the basics so that you feel confident in having that initial conversation with your lender. They will help you choose the best product for your situation to meet your goals.
Let’s start with Fixed-rate mortgages vs. Adjustable-rate mortgages.
When you get a fixed-rate mortgage, your interest rate and your monthly payment amount will stay the same for the entire loan. A lot of buyers like a fixed-rate because it is predictable.
There are adjustable-rate mortgages (ARM) and hybrid versions of this loan. If you get a fixed-period adjustable-rate mortgage (also known as hybrid ARM), you will get an initial fixed-rate for a certain time period (say 5, 7, or 10 years). After that period ends, the interest rate becomes adjustable for the rest of the loan term. You may have heard about a 5/1 ARM. That is an ARM with a 5 year introductory period and after that the rate is subject to adjustment once per year. Buyers like this loan because the rate tends to be lower during the introductory period, which might mean that you will pay less per month. Make sure that you consider whether you will be able to afford the potential increases in your rate after the introductory period. And talk to your lender about all of the details!
Next we turn to conventional loans vs. government-insured loans. A conventional loan is one that is not insured by the federal government. Conventional loans include conforming loans, non-conforming loans, jumbo loans, and portfolio loans (held by the lender on their books).
There are two main government-insured loans: FHA loans and VA loans.
FHA (Federal Housing Administration) loans are government-insured loans available to buyers (not just first-time home buyers!). The government insures the lender against loss from this loan when a buyer defaults on their loan. These programs have low downpayment options, including 3% and 3.5% down payment options. You will have to pay mortgage insurance on this type of loan.
VA loans are insured by the US Department of Veterans Affairs (VA). In order to qualify for this loan, you must be a current or former member of the US armed forces or the current or surviving spouse of one. The VA will reimburse the lender if a buyer defaults. Why do people like VA loans? You can borrow 100% of the purchase price of the house. That means that there is no down payment.
The last category to understand is conforming loans vs. jumbo loans. A conforming loan is one that meets Fannie Mae or Freddie Mac guidelines. The 2017 maximum conforming loan limit is $424,100. In areas where 115% of the local median home values exceed baseline loan limit, the maximum area loan limit is higher. For the DC metro area, the loan limit for 2017 is $636,150. A jumbo loan does not meet these standards; the size of the loan is larger than conforming loan limits. Because they do not conform, they are more risky and therefore buyers typically have to meet higher standards to qualify, may need to put down larger down payments, have reserves in their accounts, and may have higher interest rates.