*As of April 20, 2020, Quicken Loans® isn’t offering conventional adjustable rate mortgages (ARMs).
When you’re looking to buy or refinance a home, it’s important to consider which home loan is right for you because there are a variety of mortgage options. Among the things to think about are the type of loan, the kind of rate you’re going to have, the length of the term and how you plan to occupy the property.
In the following sections, we’ll touch on what you need to know to select the right mortgage for you.
What Are The Types Of Home Loans?
There are multiple ways of distinguishing between broad categories of home loans. Mortgages are usually considered either conforming or nonconforming, or conventional or nonconventional. From a technical perspective, conventional and conforming loans are synonyms. In other words, any loan that is conventional is conforming, and anything else is a nonconforming loan. However, from the understanding of an average client, there’s a distinction between the two terms. For the purpose of simplification, we’ll be explaining these things in the form that’s most familiar to those who don’t spend every day in the mortgage industry.
Conforming Vs. Nonconforming Loans
The first category that all mortgages fall into is conforming and nonconforming loans. A conforming loan is any loan that meets (or conforms to) the guidelines of government-sponsored entities Fannie Mae or Freddie Mac. Any loan that doesn’t get the backing of Fannie Mae or Freddie Mac is considered nonconforming, including loans from government agencies.
The requirements for something to be a conforming loan break down into a few categories.
Credit: In order to have a conforming loan, a client needs a qualifying credit score of 620 or higher. Beyond the score itself, negative marks on your credit can also have an impact on whether you qualify. For example, you may have a harder time qualifying or you may not qualify at all if you have multiple late mortgage or rent payments in the last year. Additionally, if you’ve had a more serious issue like a bankruptcy, you could have wait up to 4 years in order to get a mortgage. Government loans and other private lender offerings often allow you to qualify sooner than you might for a conforming loan if you have a lower credit score or dings on your credit.
Debt-To-Income Ratio: When evaluating how much house you can afford, mortgage lenders calculate your DTI ratio. This is a comparison of your gross monthly income with your monthly debts, including installment debts like a mortgage, car payment or student loan, and revolving debt like credit cards. In general, to qualify for the most possible mortgage options, you should spend no more than 43% of your income on debt payments. You generally can’t qualify for a conventional loan with a DTI above 50%. Certain nonconforming loans like those from the FHA or VA sometimes allow you to qualify with a slightly higher DTI.
Loan Limits: Loans that are above the local conforming loan limit are jumbo loans and are considered nonconforming. In general, the conforming loan limit for a one-unit property is $510,400. However, if you live in a high-cost area, limits are set on a county-by-county basis up to an absolute ceiling of $765,600. This upper limit is also the blanket limit for properties built in Alaska and Hawaii. If you have a property that has multiple units, loan limits are higher. Jumbo loans often have different interest rates and more stringent qualification requirements than a conforming or even regular government loan. As an example, Quicken Loans®requires you to make at least a 10% down payment, have a 720 median FICO®Score and have a DTI no higher than 40% to get a jumbo loan of up to $1.5 million. Requirements vary depending on the loan amount and how much you have for a down payment.
Conventional Vs. Nonconventional Loans
Conventional loans are those backed by Fannie Mae or Freddie Mac. Although both Fannie and Freddie are under government conservatorship, and there’s an implied government guarantee associated with that, neither agency is a government entity. This is in contrast with loans that actually are backed by the government from either the FHA, USDA or VA. In addition to these, jumbo loans are also considered not to be conventional.
Conventional loans are backed by either Fannie Mae or Freddie Mac. As mentioned earlier, these may also be called conforming loans.
Conventional loans have a variety of features. To qualify for nearly any conventional loan, you need a median FICO® Score of 620 or better. From an affordability standpoint, you won’t qualify for a mortgage with monthly debt payments greater than 50% of your gross monthly income.
Those are some of the basic qualifications, but to go over the nuance a little bit, let’s run through a quick pros and cons list:
- Down Payments As Low As 3%: If you’re a first-time home buyer or qualify based on income, you can purchase a one-unit primary property with as little as 3% down. In no event will the down payment for a single-family primary residence need to be more than 5%. The size of the down payment necessary does change if you’re buying a home with multiple units or using the home as a vacation residence or investment property.
- Mortgage Insurance Goes Away: If you make a down payment of less than 20% on a conventional loan, you’ll end up paying for private mortgage insurance. The good news is once you reach 20% equity or the midpoint of the loan (whichever is sooner), you can request that PMI be canceled pending a valuation by an appraiser confirming that the property hasn’t lost value at all. The 20% figure is based on getting the 20% equity through your payments. It’s possible to have PMI canceled based on things like home improvements or general market value increases, but the timing and amount of equity necessary may change.
- Occupancy Flexibility: Unlike government loans, conventional loans through Fannie Mae and Freddie Mac aren’t restricted to primary residences. You can use them to buy second homes and investment properties, as long as you meet the necessary qualifications.
- Stricter Guidelines: You’ll need a higher qualifying credit score and lower DTI than you might on some government loan options. You could also end up with a higher necessary down payment depending on your situation.
- Mortgage Insurance: While there’s mortgage insurance on conventional loans, no one likes paying PMI at all if they can avoid it.
VA loans are available to eligible active-duty service members, reservists, veterans and surviving spouses of those who passed in action or as a result of a service-connected disability. There’s no down payment required. While the VA doesn’t set specific guidelines for credit scores, lenders have their own policies. Quicken Loans requires you to have a 620 credit score in order to be eligible.
- No Down Payment Required: You don’t need a down payment when getting a VA loan. This could enable you to save on closing costs.
- Be Able to Afford More: If you’re getting a fixed-rate loan through the VA, you can qualify with a DTI ratio as high as 60%, higher than any nonstreamline refinance loans from any of the major mortgage investors. This translates into being able to afford more home if you need it.
- Convert All Of Your Equity Into Cash: The VA loan is the only one you can use to take cash out up to the full value of your property. Quicken Loans requires that you have a 680 median FICO®
- VA Funding Fee: While they don’t have mortgage insurance, VA loans do have a funding fee that’s paid upfront. Depending on your service status, down payment and the number of times you’ve used a VA loan, this fee is anywhere between 1.4% – 3.6% of your loan amount generally. For VA Streamlines (refinancing from one VA loan into another to lower your rate or change your term), the fee is 0.5%. In many cases, if you don’t want to pay it at closing, it can be built into the loan amount. Surviving spouses, active-duty servicemembers who have received a Purple Heart, and those receiving VA disability are exempt from the funding fee.
- Limited Audience: In order to qualify for a VA loan, you need to be an eligible member of the military, a veteran or a surviving spouse.
FHA loans allow you to qualify with less-than-perfect credit. You can get an FHA loan with a qualifying credit score of as low as 500, but you’ll need a 10% down payment, and this option is offered by very few lenders. Quicken Loans and most others require a qualifying score of 580 to get a loan with a 3.5% down payment.
- Flexible Credit Guidelines: You can qualify with a score as low as 580. Additionally, if you have a score higher than 620, qualifying DTI is decided on a case-by-case basis, but affordability guidelines can be as flexible as any loan outside the VA, depending on your situation. Additionally, if you have blemishes like account collections or bankruptcies, you may be able to get a loan sooner than you otherwise might with other programs. Finally, you can qualify with nontraditional credit sources like cell phone, electric and cable bills through manual underwriting if you don’t have a traditional credit history.
- Low Down Payment Option: You only need to come up with 3.5% of the purchase price.
- Mortgage Insurance Premium: With any FHA loan, you’ll pay both an upfront and a monthly mortgage insurance payment. The upfront payment can be built into the loan amount. If your down payment is 10% or more, you pay MIP for 11 years. If the down payment is less than 10%, MIP is paid for the life of the loan.
USDA loans are for those with qualifying incomes who want to buy property either in a rural area or one on the edge of suburbia. If you want to live in that area and meet the income guidelines, you can purchase a one-unit property without a down payment.
- No Down Payment Required: Having no down payment allows you to spend money on other instances related to moving.
- Lower Fees Than FHA: There’s both an upfront and annual guarantee fee (equivalent to mortgage insurance), but they are lower than similar fees for FHA loans.
- Eligibility Area: If you want to get a USDA loan, you have to be in an eligible area. The USDA maintains an eligibility map.
- Income Limits: You can’t get a USDA loan if your household makes more than 115% of the area median income. The household part is an important distinction because other loans with income limits typically only count those named on the loan.
- Guarantee Fees: Although the fees are lower than they would be for FHA, they still exist. Additionally, monthly guarantee fees stick around for the life of the loan no matter what.
- You Can’t Take Cash Out: With a USDA loan, you can only buy a single-family primary property or refinance.
- No Working Farm Property: Despite being aimed at rural and underdeveloped areas, your property can’t be on the site of a working farm.
What Are The Different Loan Rate Types?
When you get a mortgage, there are a couple of different interest rate structures. You either have a fixed-rate mortgage or an adjustable rate mortgage that changes over time subject to market conditions and caps on increases. Let’s dig in and get a little more detail.
With a fixed-rate mortgage, you’re going to pay the same amount of annual interest every year over the life of the loan. This means that your monthly payment stays more constant. There are a couple of scenarios in which it could change, including the following:
- If you made a down payment of less than 20%, once you reach that 20% equity amount on a conventional loan, mortgage insurance can be canceled with a home valuation to verify that your home hasn’t lost value. If you don’t request cancellation, PMI will automatically cancel at 22% equity or the midpoint of the loan, whichever is first.
- Your mortgage payment can also change if your property taxes or homeowners insurance go up or down, assuming you have an escrow account that splits these costs into monthly fees added to your mortgage.
Your mortgage payment is more constant. Because of this, it can be easier to plan your budget and think about future expenses.
Interest rates won’t be as low on a fixed-rate mortgage as the initial rate would be on an ARM. The reasoning for this is that with a fixed rate, the lender has to attempt to forecast the cost of inflation more than they do with a rate that eventually adjusts.
Adjustable Rate Mortgage (ARM)
ARMs have rates that adjust over time. However, they don’t move right away. ARMs have what’s called a teaser period at the beginning of the loan. During this time frame which can last 5, 7 or 10 years typically, the rate is fixed. At the end of the fixed period, the rate adjusts up or down based on market conditions, often once per year.
When the rate adjusts, it’s tied to a market index. Conventional loans are based on the 1-year London Interbank Offered Rate. The LIBOR is being phased out, but it’s still going to be a couple of years before it’s fully replaced. Government loans from the FHA and VA base their rate on the 1-year Constant Maturity Treasury. To get to the final rate, the index level on the day of adjustment is added to a margin.
It’s also important to note that even if interest rates go up dramatically, they can’t go up indefinitely year after year. There are caps on the initial adjustment, each subsequent change and over the lifetime of the loan. The easiest way to explain this is to tie it all together with an example. Let’s say you see an ARM that’s being advertised as a 5/1 ARM with 2/2/5 caps.
Looking at those first two numbers, the 5 represents the number of years the rate stays fixed. The 1 represents how often each year that the rate adjusts following the end of the fixed-rate time frame, in this case once.
Moving to the caps, the interest rate can’t go up more than 2% initially. That’s also the case for each subsequent adjustment if you look at the second number. In no event can the interest rate go up more than 5% over the entire life of the loan.
The only thing limiting how much an interest rate could potentially go down based on market conditions is the margin. When an interest rate adjusts, the loan is re-amortized so that it fully pays off by the end of the term. Typically, the terms for ARMs are 30 years, although they don’t necessarily have to be.
- The teaser interest rate is lower than fixed rates for a comparable term. Investors can have the rate start lower since adjustment is built into the loan, meaning they don’t have to plan as far out for inflation.
- You can take advantage of the lower interest rate to pay down your loan sooner. If you pay down your loan during the fixed period, you’ll end up with a lower balance than you would otherwise have at the time of the adjustment. Because the loan amortized this when adjustments are made, if you have a lower balance, the required monthly payment could be lower than it otherwise would be. This would help lessen the effect of an uptick in interest rates.
- This might be good for people who move around a lot. If you’re someone who moves quite a bit, you may find that you end up selling your house and paying off your loan before the rate ever gets a chance to adjust.
- You don’t have payment certainty. Because the payment adjusts, you don’t have any certainty as far as what your payment will be after the fixed-rate period at the beginning of the loan.
- You won’t always be able to refinance into a fixed rate. One of the ways that people often try to avoid the rate going up each year at the end of the teaser time frame is to refinance into a fixed-rate loan, but you have to be able to qualify for that. Even if your credit is in shape and you make a good income, you could have a difficult time if property values have dropped.
What Are The Different Loan Terms?
The terms of a mortgage can technically refer to any of the contract provisions associated with a mortgage, but typically, when loan terms are referred to, it specifically references the amount of time you have to pay off the loan.
When it comes to choosing a loan term, you have several different options, each with its pros and cons.
The 30-year term is generally the longest you can get. The only exception is if you have trouble making your payments and your mortgage servicer approves a loan modification for a longer term. Although this isn’t always the case, most ARMs come with a 30-year term.
Here are the pros and cons of a mortgage with a 30-year term.
The following are benefits of a 30-year mortgage.
- It’s the cheapest monthly payment you can get if all other things are equal because it’s the longest monthly term. This makes it easier to fit into your budget.
- Because there's a lower monthly payment, you do have a level of greater flexibility. You can also make extra payments toward the principal in order to pay less in interest over time, and even cut months or years off the loan. Just make sure you’re aware of whether your lender charges prepayment penalties and for how long. Quicken Loans does not.
There are downsides to a 30-year mortgage.
- With a longer term, you’ll end up paying a lot more interest over time. This is because investors need some motivation in order to buy a loan with a longer payoff period.
- Because you owe more interest, if you’re in the home for a short period of time, your payoff from selling the house might not be as high.
With a 15-year mortgage you pay off your loan in a much shorter time frame. There are benefits and downsides to this.
- With a shorter payoff time frame, you end up paying less interest in exchange for giving the investor the quicker payoff.
- In addition to paying less interest by virtue of the time frame, you get a lower interest rate as well.
- Because of the shorter term, your payment would be double what it would be on a 30-year fixed.
Although everyone thinks about 30- and 15-year terms, there are other options. On government loans, you also have 20- and 25-year options for terms.
On the conventional side, you can get a fixed-rate term of anywhere between 8 – 30 years, so you can really customize your options. We call this the YOURgage®. You may find that this gives you the opportunity to shave years off your term while still being comfortable with your payment because you have the flexibility to pick your exact term.
The final major thing to think about when deciding what type of loan is right for you is how you plan to occupy the property.
If the home is going to be your primary residence, meaning you live in it for more than the majority of the year, you’re going to have the most possible loan options. You can buy up to four units with a conventional loan. The minimum down payment for a two-unit property is 15%, while a property that’s three or four units is 20%. With a VA loan, you can get up to four units with no down payment as long as you meet VA eligibility requirements. At Quicken Loans, you can purchase up to a two-unit primary residence with a 3.5% down payment. It’s important to note that on a USDA loan, you can only purchase a single-family home no matter the circumstance.
Once you get into vacation homes and rental properties, you can only get a conventional loan. For a second home, the minimum down payment is 10%. When you get into investment properties, it’s a minimum 15% down payment for a single-unit property. For a multiunit rental property, the minimum down payment is 25%.
Which Mortgage Is Right For You?
In order to pick the right mortgage, you need to take into account all of these factors and your personal situation in order to determine which one is the right option. For example, if you’re only going to be in a property for a short period of time, you might not choose to go with a 30-year fixed because you’re going to end up paying more interest by the time you’re ready to sell, depending on the mortgage rates. At the same time, a 30-year term would give you the cheapest monthly payment, which could make it the easiest to fit into your budget. You just need to be aware of what your options are and how it fits in with the rest of your financial goals.
After 3,600 words, picking the right mortgage is simple, right? There’s been a lot of information thrown at you, so needing a little help could be understandable. In order to find the option that truly makes the most sense for you, you can get started online or give us a call at (833) 230-4553.