Weather you are a first time home buyer or a seasoned investor, 1st Los Angeles Mortgage will guide you through the many loan options that are available to you to ensure you are getting the mortgage that best suits your needs.
- Getting pre-approved for a mortgage will be a crucial first step in purchasing your home, and there are several factors for choosing the most appropriate one.
- Lenders will evaluate your creditworthiness and your ability to repay based on your income, assets, debts, and credit history.
- In choosing a mortgage, you’ll need to decide on a fixed or adjustable rate, the number of years to pay off your mortgage, and the size of your down payment.
- Conventional loans are mortgages that are not insured or guaranteed by the federal government.
- Depending on your circumstances, you may be eligible for more favorable terms through an FHA or VA federal government backed mortgage.
Conventional loans are mortgages that are not insured or guaranteed by the federal government. They are typically fixed-rate mortgages. Although their stricter requirements for a bigger down payment, higher credit score, lower-income to debt ratios, and potential to need private mortgage insurance make them the most difficult to qualify for, conventional mortgages are usually less costly than guaranteed mortgages.
Conventional loans are defined as either conforming loans or non-conforming loans. Conforming loans comply with guidelines such as loan limits set forth by the government-sponsored enterprises (GSEs) Fannie Mae or Freddie Mac because they or various lenders often buy and package these loans and sell them as securities in the secondary market. The 2020 loan limit for a conventional mortgage in most California Counties is $510,400. Conforming high balance limits can be as high as $765,600 in most California counties. These loan limits are on single family residences. Two, Three, and Four unit homes have higher loan limits.
A loan made above the conforming or conforming high balance loan limit amount is called a jumbo loan and usually carries a slightly higher interest rate, because these loans carry more risk (since they involve more money), making them less attractive to the secondary market. For non-conforming loans, the lending institution underwriting the loan, usually a portfolio lender, set their own guidelines.
The Federal Housing Administration (FHA), part of the U.S. Department of Housing and Urban Development, provides various mortgage loan programs. An FHA loan has lower down payment requirements and is easier to qualify for than a conventional loan. FHA loans are excellent for first-time home buyers because, in addition to lower upfront loan costs and less stringent credit requirements, you can make a down payment as low as 3.5%. FHA loans cannot exceed the statutory loan limits described above.
The downside is FHA borrowers must pay a mortgage insurance premium (MIP), rolled into their mortgage payments along with an up front mortgage premium which is financed into the loan. This mortgage insurance benefits the lender in case of default and not the borrower.
The U.S. Department of Veterans Affairs (VA) guarantees VA loans. The VA does not make loans itself, but guarantees mortgages made by qualified lenders. These guarantees allow veterans and service people to obtain home loans with favorable terms, usually without a down payment. In most cases, VA loans are easier to qualify for than conventional loans. Lenders generally limit the maximum VA loan to conventional mortgage loan limits. Before applying for a loan, request eligibility from the VA. If you are accepted, the VA will issue a certificate of eligibility you can use to apply for the loan.
In addition to these federal loan types and programs, state and local governments and agencies sponsor assistance programs to increase investment or home ownership in certain areas.
Equity and Income Requirements
Home mortgage loan pricing is determined by lenders based on the creditworthiness of the borrower and risk factors. In addition to checking your FICO score from the three major credit bureaus, lenders will calculate the loan-to-value ratio (LTV) and the debt-service coverage ratio (DSCR) to set the amount they’ll loan you, and the interest rate.
LTV is the amount of actual or implied equity that is available in the collateral being borrowed against. For home purchases, LTV is determined by dividing the loan amount by the purchase price of the home. Lenders assume that the more money you are putting up (in the form of a down payment), the less likely you are to default on the loan. The higher the LTV, the greater the risk of default, so lenders will charge more.
The debt service coverage ratio (DSCR) determines your ability to pay the mortgage. Lenders divide your monthly net income by the mortgage costs to assess the probability that you may default on the mortgage. Most lenders will require DSCRs of greater than one. The greater the ratio, the greater the probability that you will be able to cover borrowing costs and the less risk the lender takes on. The greater the DSCR, the more likely a lender will negotiate the loan rate because even at a lower rate, the lender receives a better risk-adjusted return.
Be sure to include any type of qualifying income you can on your mortgage application. Sometimes an extra part-time job or other income-generating business can make the difference between qualifying or not qualifying for a loan or receiving the best possible rate.
Private Mortgage Insurance
Loan to Value (LTV) will also determine whether you will be required to purchase private mortgage insurance (PMI). PMI insulates the lender from default by transferring a portion of the loan risk to a mortgage insurer. Most lenders require PMI for any loan in 1st lien position with an LTV greater than 80%, meaning any loan where you own less than 20% equity in the home. The amount being insured and the mortgage program will determine the cost of mortgage insurance and how it’s collected.
Most mortgage insurance premiums are collected monthly along with tax and property insurance escrows. Once LTV is equal to or less than 78%, PMI is supposed to be eliminated automatically. You may be able to cancel PMI once the home has appreciated enough in value to give you 20% equity and a set period has passed, such as two years. Some lenders, such as the FHA, will assess the mortgage insurance as a lump sum and capitalize it into the loan amount.
There are ways to avoid paying for PMI. One is not to borrow more than 80% of the property value when purchasing a home; the other is to use home equity financing or a second mortgage to put down more than 20%. The most common program is called an 80-10-10 mortgage. The 80 stands for the LTV of the first mortgage, the first 10 stands for the LTV of the second mortgage, and the third 10 represents the equity you have in the home.
Although the rate on the second mortgage will be higher than the rate on the first, on a blended basis, it should not be much higher than the rate of a 90% LTV loan. An 80-10-10 mortgage can be less expensive than paying for PMI and also allows you to accelerate the payment of the second mortgage and eliminate that portion of the debt quickly so you can pay off your home early.
Some lenders also offer lender paid mortgage insurance in exchange for a slightly higher interest rate. The potential downside to this option is higher total financing costs over time. While PMI can be petitioned to be removed once you reach 80% or lower LTV, the higher interest rate on lender paid PMI cannot be.
Fixed vs. Adjustable Rate Mortgages
Another consideration is whether to obtain a fixed-rate or adjustable-rate (or variable rate) mortgage. In a fixed-rate mortgage, the rate does not change for the entire period of the loan. The obvious benefit of getting a fixed-rate loan is that you know what the monthly loan costs will be for the entire loan period. And, if prevailing interest rates are low, you’ve locked in a good rate through the term of the loan.
A variable rate mortgage, such as an interest-only mortgage or an adjustable-rate mortgage (ARM), is designed to assist first-time home buyers or people who expect their incomes to rise substantially over the loan period. Adjustable rate loans usually allow you to obtain lower introductory rate during the initial few years of the loan, allowing you to qualify for more money than if you had tried to get a more expensive fixed-rate loan. Of course, this option can be risky if your income does not grow in step with the increase in interest rate. The other downside is that market interest rates are uncertain. If interest rates rise, your monthly payment will rise with them.
How Adjustable Rate Mortgages (ARM) Work
The most common types of ARMs are for one, three, five, seven, and ten year periods. The initial interest rate is normally fixed for a period of time and then resets periodically, often every month. Once an ARM resets, it adjusts to the market rate, usually by adding some predetermined spread (percentage) to the prevailing U.S. Treasury rate. Although the increase is typically capped, an ARM adjustment can be more expensive than the prevailing fixed-rate mortgage loan to compensate the lender for offering a lower rate during the introductory period.
Interest-only loans are a type of ARM in which you only pay mortgage interest and not principal during the introductory period until the loan reverts to a fixed, principal-paying loan. Such loans can be very advantageous for first-time borrowers because only paying interest significantly decreases the monthly cost of borrowing and will allow you to qualify for a much larger loan. However, because you pay no principal during the initial period, the balance due on the loan does not change until you begin to repay the principal.
Be Prepared in this Competitive Purchase Market
1st Los Angeles Mortgage will help you review your best home loan options. We will provide you with the information necessary so that you may determine how much home you can actually afford. You will then be prepared to search for homes that meet your purchase criteria and present purchase offers.
In today’s highly competitive home purchase market, you will want to present yourself as the strongest buyer possible. 1st Los Angeles Mortgage will arm you with the tools and documentation to do just this. Rather than just provide the listing agent with a pre-qual letter that is not worth the paper it is printed on, we will provide them with an actual FNMA conditional approval letter, FICO Score Disclosure, and supporting asset documentation to present with your purchase offer. We will then immediately follow up with a personal phone call to the agent, introduce ourselves as your preferred lender, and inform them that we have collected the necessary documentation along with loan approval to close on your purchase well within the scheduled escrow closing period. We will then request the closing agent and title agent contact information so that we can hit the ground running. As your single point of contact, we will be here to answer any questions and guide you through all aspects of your new home purchase from offer acceptance through closing.