Loan Types and Programs
There are an infinite number of loan types out there, and lenders are constantly coming up with creative ways to wrangle in new homeowners. The type of home loan you choose can make or break you as a borrower, so make sure you fully understand it before making any kind of commitment.
These days you ll probably come across ridiculous loan programs that seemingly allow anyone to qualify for a home loan. There are 1% start rate loans, often referred to as neg-ams or pick-a-payment programs, and 40-yr and 50-yr loans that stretch the mortgage payment out over what seems like a lifetime.
Most prospective homeowners these days seem to be interested in 100% financing, generally because they have don t have the assets necessary for a down payment. Unfortunately, the proliferation of these types of home loan programs have increased the number of high-risk borrowers in the United States at an alarming rate.
That may explain the surge in mortgage defaults and foreclosures over the past several years.
But if you take the time to educate yourself on the many home loan types out there, you ll effectively decrease your chances of defaulting on your mortgage. That said, let s talk about the many different loan types and programs available today.
Before getting into specific loan programs, I want to highlight the types of loans available to potential homeowners.
Conforming Loans and Non-Conforming Loans
One way home loans are differentiated is by their GSE eligibility. If the loan meets requirements set forth by Fannie Mae and Freddie Mac, it is considered a conforming loan. If the loan doesn s meet all the underwriting requirements set forth by the pair of GSEs, it is considered non-conforming.
One of the main guidelines that determines whether a mortgage is conforming or not is loan amount. Generally, a mortgage with a loan amount below $417,000 is considered conforming, whereas any loan amount above $417,000 is considered a jumbo loan. However, in Alaska and Hawaii the confirming limit is $625,500.Note that the conforming limit may change annually, and has risen quite a bit in the past few years as housing prices skyrocketed.
A jumbo loan may meet all of Fannie Mae and Freddie Mac’s loan underwriting guidelines, but if the loan amount exceeds the conforming limit, it will be considered non-conforming and carry a higher mortgage rate as a result.
If your loan amount is on the fringe of the conforming limit, sometimes simply dropping your loan amount a few thousand dollars can lower your mortgage rate tremendously, so keep this in mind anytime your loan amount is near the limit.
Conventional Loans and Government Loans
Mortgages are also classified as either conventional loans or government loans. Conventional loans can be conforming or jumbo, but are not insured or guaranteed by the government.
Then there are government loans, such as the widely popular FHA loan. This type of mortgage is backed by the Federal Housing Administration (FHA). Another common government loan is the VA loan, backed by the Department of Veteran Affairs. The max loan amount for these types of loans varies by county. There s even a USDA home loan backed by the same folks that grade steaks!
Now that you know a bit about different home loan types, we can focus on home loan programs. As I mentioned earlier, there are a ton of different loan programs out there, and more seem to surface everyday. Let s start with the most basic of loan programs, the 30-year fixed-rate loan.
The 30-year fixed loan is as simple as they come. Most mortgages are based on a 30-year amortization, and the 30-year fixed is no different.
The 30-year fixed loan is just how it sounds, a loan with a 30-year term that is fixed for 30 years. What this is means is that the loan will take 30 years to pay off, and the rate will stay fixed during those entire 30 years. There isn t much else to it.
Let s say you secure a rate of 6.5% on a 30-year fixed loan with a loan amount of $500,000. You ll have monthly mortgage payments of $3160.34 for a total of 360 months, or 30 years. You will be required to pay the same amount each month until the loan is paid off. So the total amount you would pay on a $500,000 loan at 6.5% over 30 years would be $1,137,722.40.
Total Interest Paid over Life of Loan: $637,722.44
Interest Paid in 2006: $32,335.45
Interest Paid in 2007: $31,961.17
Average Monthly Interest Paid over Life of Loan: $1,771.45
You will also need to pay taxes and insurance on top of this mortgage payment, so keep that in mind when figuring out how much house you can afford.
This sounds steep, but most people don t stay in a 30-year loan for 30 years. They either pay it down quicker by making higher monthly payments (biweekly mortgage payments), or they may sell or refinance the loan.
Another common and simple to understand loan is the 15-year fixed loan. This works exactly like the 30-year loan except the same fixed payment is made in half the time, 180 months or 15 years. Obviously the payment will be much higher, but you will pay less interest and gain more home equity in a shorter amount of time. People who have an ample amount of income usually prefer this type of loan to reduce the overall cost of financing a mortgage.
This is how it breaks down:
Total Interest Paid over Life of Loan: $283,996.63
Interest Paid in 2006: $31,900.36
Interest Paid in 2007: $30,536.41
Average Monthly Interest Paid over Life of Loan: $1,577.76
The monthly payment is significantly higher, but the amount of total interest paid over the life of the loan is much less. Because you re putting more money towards the equity of the home, you paying less interest each month, which you ll see as the $1.577.76 figure as compared to the $1,771.45 you d pay on a 30yr fixed loan. That s nearly $200 a month that you would save in interest charges by electing to take a 15-year fixed mortgage.
Although the monthly payment is markedly higher than the 30 year fixed mortgage, the total interest paid during the 15 year loan is substantially lower. It may seem like the obvious choice, but it s more complicated if you factor in tax deductions and the power of leverage. Not to mention if you can afford a monthly mortgage payment that high.
Learn about other types of mortgage programs including: