Conventional Loans
Conventional loans are viewed as the most secure loans because their loan-to value ratios are often lowest. Usually, the ratio is 80 percent of the value of the property or less because the borrower makes a down payment of at least 20 percent. The security for the loan is provided solely by the mortgage; the payment of the debt rests on the ability of the borrower to pay. In making such a loan, the lender relies primarily on its appraisal of the property. Information from credit reports that indicates the reliability of the prospective borrower is also important. No additional insurance or guarantee on the loan is necessary to protect the lender’s interest. In conventional loans, the government is not involved.
Lenders can set criteria by which a borrower and the collateral are evaluated to qualify for a loan. Today, the secondary mortgage market has a significant impact on borrower qualifications, standards for the collateral, and documentation procedures followed by lenders. Loans must meet strict criteria to be sold to Fannie Mae and Freddie Mac. Lenders still can be flexible in their lending decisions, but they may not be able to sell unusual loans in the secondary market.
DETERMINING LTV
If a property has an appraised value of $100,000, secured by a $90.000 loan, the LTV is 90 percent: $90,000/$100,000 = 90%
LOW LTV
High Down Payment
Small Loan
HIGH LTV
Low Down Payment
Large Loan
Importance of credit scores
The creditworthiness of buyers also is a key element in qualifying for a conventional loan today. Underwriters consider several factors known about the applicant before determining whether to make the loan (e.g., credit scores and payment history). Today, with the exception of FHA loans and a few nonconforming loans, the interest rate available to borrowers is largely based on credit scores, which can range from 300 to 850. The higher the credit score, the lower the risk to the lender. Lenders offer these borrowers lower interest rates and may permit a smaller down payment. Lenders almost always require a higher interest rate and/or a larger down payment for those with lower scores. Today, the FHA is the best source for a mortgage loan for a borrower with a lower credit score.
The nonconforming market accepts loans that do not meet Fannie Mae and Freddie Mac requirements. Examples of such loans include loan amounts that exceed the limits set by Fannie Mae and Freddie Mac, loans secured by a property that does not qualify (e.g., commercial, more than four family units), and factors specific to the individual borrower (e.g., no down payment, high debt-to-income ratios, or the self-employed borrower does not show enough income to qualify).
Importance of credit history
In addition to credit scores, underwriters consider two years in detail and up to seven years of repayment history, whether or not the applicant has made timely payments, especially for rent and/or mortgage loans. A payment is considered late if more than 30 days past due. Underwriters especially look for bankruptcies, judgments, and foreclosures. Applicants who are consistently more than 30 days late for rent or mortgage payments will most likely be ineligible for VA and FHA loans and others that are sold to Fannie Mae and Freddie Mac.
Judgments, foreclosures, bankruptcies
Fannie Mae, Freddie Mac, FHA, and the VA require that all judgments be paid in full, and they prefer that the judgments be at least two years old. Generally, the nonconforming market is open to funding and buying loans even if the judgment has not been paid so long as the judgment does not impact title.
For most bankruptcy actions, both Fannie Mae and Freddie Mac require four years to re-establish credit. Fannie Mae and Freddie Mac may purchase loans made to someone who was in foreclosure. However, they require that the foreclosure of the borrower’s primary residence was at least three years prior and caused by circumstances out of the borrower’s control, such as the death of the primary wage earner, job layoff, or long-term serious illness. Although the nonconforming market may purchase a loan, it often requires a substantial down payment if the foreclosure is less than three years old.
Financial Qualifications
To qualify for a conventional loan under Fannie Mae guidelines,
Loans that meet these criteria are called conforming loans and are eligible to be sold in the secondary market. Loans that exceed the limits are referred to as nonconforming loans and are not marketable in the secondary market but, instead, are generally held in the lender’s investment portfolio.
Conforming loans with larger ratios may be available in certain situations. Both Fannie Mae and Freddie Mac currently have a variety of conforming affordable loan products with qualifying ratios of 33 percent for housing expense and up to 38 percent for total debt. These loans only require a 3 percent down payment but are subject to certain income limitations and may require the borrowers to attend homeownership classes.
Private Mortgage Insurance
One way a borrower can obtain a mortgage loan with a lower down payment is by obtaining private mortgage insurance (PMI). In a PMI program, the borrower purchases an insurance policy that provides the lender with funds in the event the borrower defaults on the loan. This allows the lender to assume more risk so that the loan-to-value ratio is higher than for other conventional loans. The borrower purchases insurance from a private mortgage insurance company as additional security to insure the lender against borrower default.
PMI protects the top 20 to 30 percent of the loan against borrower default. The borrower pays a monthly fee, which can be financed in with the loan, while the insurance is in force. Because only a portion of the loan is insured, the lender must allow the borrower to terminate the coverage once the loan is repaid to a certain level.
Under the Homeowners’ Protection Act of 1998 (implemented in 1999), PMI must terminate automatically when the borrower reaches a 22 percent equity position based on the original value of the property at the time the loan was originated with no allowance for appreciation or depreciation if the loan was written after July 29, 1999, and the borrower is current on mortgage payments.
FHA-Insured Loans
The Federal Housing Administration (FHA), which operates under HUD, neither builds homes nor lends money. The common term FHA loan refers to a loan that is insured by the agency. These loans must be made by FHA-approved lending institutions. The FHA insurance provides security to the lender in addition to the real estate. As with private mortgage insurance, the FHA insures lenders against loss from borrower default.
Certain technical requirements must be met before the FHA will insure the loans. These requirements include the following:
If the purchase price exceeds the FHA-appraised value, the buyer may pay the difference in cash as part of the down payment. Some exceptions are made for special programs, such as the Good Neighbor Program.
Other types of FHA loans are available, including:
Specific standards for condominium complexes and the ratio of owner-occupants to renters must be met for a loan on a condominium unit to be financed through the FHA insurance programs.
A qualified buyer may assume an existing FHA-insured loan. The application consists of a credit check to demonstrate that the person assuming the loan is financially qualified. The process is quicker and less expensive than applying for a new loan. Sometimes, the older loan has a lower interest rate and no appraisal is required.
FHA Assumption rules
The assumption rules for FHA-insured loans vary, depending on the dates the loans were originated, as follows:
Discount points
The lender of an FHA-insured loan may charge discount points in addition to a loan origination fee. The payment of points is a matter of negotiation between the seller and the buyer. As of November 2009, if the seller pays more than 6 percent of the costs normally paid by the buyer (such as discount points, the loan origination fee, the mortgage insurance premium, buy-down fees, prepaid items, and impound or escrow amounts), the lender will treat the payments as a reduction in sales price and recalculate the mortgage amount accordingly.
VA-Guaranteed Loans
The Department of Veterans Affairs (VA) is authorized to guarantee loans to purchase or construct homes for eligible veterans and their spouses (including un-remarried spouses of veterans whose deaths were service-related).
Eligibility is defined as veterans who:
With over 25.5 million veterans and service personnel eligible, a VA loan is desirable and has many benefits. The VA assists veterans in financing the purchase of homes with little or no down payments at market interest rates. The VA issues rules and regulations that set forth the qualifications, limitations, and conditions under which a loan may be guaranteed.
Like the FHA loan, VA loan is something of a misnomer. The VA does not normally lend money; it guarantees loans made by lending institutions approved by the agency. The term VA loan refers to a loan that is not made by the agency but is guaranteed by it.
There is no VA dollar limit on the amount of the loan a veteran can obtain; this limit is determined by the lender and qualification of the buyer. The VA limits the amount of the loan it will guarantee.
IN PRACTICE The VA loan guarantee is tied to the current conforming loan limit for Fannie Mae and Freddie Mac. Typically, lenders will loan four times the guarantee (for example, a conforming loan of $417,000 ÷ 4 = $104,250 VA guarantee).
To determine what portion of a mortgage loan the VA will guarantee, the veteran must apply for a certificate of eligibility. This certificate does not mean that the veteran automatically receives a mortgage. It merely sets forth the maximum guarantee to which the veteran is entitled. For individuals with full eligibility, no down payment is required for a loan up to the maximum guarantee limit.
The VA also issues a certificate of reasonable value (CRV) for the property being purchased. The CRV states the property’s current market value based on a VA-approved appraisal. The CRV places a ceiling on the amount of a VA loan allowed for the property. If the purchase price is greater than the amount cited in the CRV, the veteran may pay the difference in cash. The CRV is based on an appraisal. New VA regulations allow only one active VA loan at a time, and a veteran may own only two properties that were acquired using VA loan benefits. VA benefits will never expire as long as the previous benefit use has been paid.
The VA borrower pays a loan origination fee to the lender, as well as a funding fee to the Department of Veterans Affairs. The funding fee depends on whether it is first-time use (2.15 percent) or a subsequent use (3.15 percent). The funding fee drops with down payments of 5 percent or more. Reservists and National Guard veterans pay higher funding fees. Reasonable discount points may be charged on a VA-guaranteed loan, and either the veteran or the seller may pay them.
VA Prepayment privileges
As with an FHA loan, the borrower under a VA loan can prepay the debt at any time without penalty.
Assumption rules
March 1, 1988, the VA must approve the buyer and assumption agreement. The original veteran borrower remains personally liable for the repayment of the loan unless the VA approves a release of liability. The release of liability will be issued by the VA only if :
VA legislation
The Veterans Millennium Health Care and Benefits Act of 1999, Public Law 106-117, authorized the VA to restore the home loan eligibility of surviving spouses who lost such eligibility as a result of remarriage if the remarriage has been terminated by death or divorce.
Agricultural Loan Programs
The Farm Service Agency (FSA) is a federal agency of the Department of Agriculture. The FSA offers programs to help families purchase or operate family farms.
Through the rural Housing and Community Development Service (RHCDS), it also provides loans to help families purchase or improve single-family homes in rural areas. FSA loan programs fall into two categories: guaranteed loans, made and serviced by private lenders and guaranteed for a specific percentage by the FSA, and loans made directly by the FSA.
The Farm Credit System (Farm Credit) provides loans to farmers, ranchers, rural homeowners, agricultural cooperatives, rural utility systems, and agribusinesses. Unlike commercial banks, Farm Credit System banks and associations do not take deposits. Instead, loanable funds are raised through the system-wide sale of bonds and notes in the nation’s capital markets.
Farmer Mac (formerly the Federal Agricultural Mortgage Corporation, or FAMC) is another government-sponsored enterprise (GSE) that operates similarly to Fannie Mae and Freddie Mac but in a context of agricultural loans. It was created to improve the availability of long-term credit at stable interest rates to America’s farmers, ranchers, and rural homeowners, businesses, and communities. Farmer Mac pools or bundles agricultural loans from lenders for sale as mortgage-backed securities.
