Unless you have excess cash available for real estate purchases, lending is an important component of purchasing a home. Since the Conforming Loan limit for 2021 was recently announced, I thought it would be a good time to do a refresher on what you should know when it comes to loans.
There can be a significant difference between the interest rates and qualification requirements for obtaining the various types of loans that are available to buyers and the conforming loan & high conforming limit number is a key factor. For single homes in our local area (Snohomish, King & Pierce Counties – where the high conforming limit applies) the 2020 the loan limit is $776,250 and it was just announced that for next year, the 2021 limit is $822,375. Any loans, greater than this amount, will be considered nonconforming – which means it cannot be sold to Fannie Mae or Freddie Mac – typically these are called Jumbo loans.
Tip: The limit value is the loan value – not the price you pay for the home – so you can pay as much as you want over the loan amount and still be able to avoid using a nonconforming loan to purchase a home. Note, the limit is higher for 2-4 unit properties.
General Loan Types
There are a variety of loans that you can use to purchase a home – here are the main ones – a lender can give you details on the variations that might be best for you.
- FHA Loan: This is a mortgage that is insured by the Federal Housing Administration (FHA) and issued by an FHA-approved lender. FHA loans require lower minimum down payments and lower credit scores than many other loans. These are often popular with first time home buyers.
Pros: You can make down payments as low as 3.5% with a credit score of at least 580 and as low as 10% if your credit score is at least 500.
Tip: 100% of your down payment can come from savings, a financial gift from a family member, and/or a grant for down-payment assistance.
Cons: You are required to purchase mortgage insurance premium (MIP) – which in 2020 had an upfront cost of 1.75% of the loan + annual premium of .45%-1.05%. The annual premium is due for either 11 years or the life of the loan depending on the loan to value and length of the loan.
FHA Loan Types: There are 5 types of FHA Loans (1) Traditional mortgages, (2) Home Equity Conversion Mortgage (Reverse Mortgage for age 62+), (3) FHA 203 (k) Improvement Loan, (4) FHA Energy Efficient Mortgage, and (5) Section 245(a) Loan.
- VA Loan: This is a mortgage that is provided only to service members, veterans, and eligible surviving spouses and the VA guarantees a portion of the loan. In 2020 the VA loan limit (that was tied to the conforming limit number) was eliminated. However, this doesn’t mean unlimited borrowing power since lenders can still require that you have sufficient income and meet their credit requirements to qualify for the loan.
Pros: No or minimal down payment required, no required mortgage insurance cost.
Cons: They are often viewed as higher risk than cash/non-VA loans and so less competitive in a sellers’ market (Tip: a Broker who understands VA loans can often sell around this perceived negative).
- Conventional: Loans that are not backed by FHA but meet the criteria so they can be sold to Freddie Mac & Fannie Mae. You can have fixed-rate or adjustable-rate conventional loans. You can also get a CHOICERenovation loan (guaranteed by Freddie Mac) or a HomeStyle Loan (guaranteed by Fannie Mae) if you need to include renovations in your loan.
Pros: Flexible down payment amounts starting at 3%, flexible loan terms 10, 15, 20, or 30 years. No PMI (private mortgage insurance), generally interest rates for conventional loans are lower and more lenders offer conventional loans. A conventional loan with 20%+ down payment is viewed as low risk by sellers and can be a competitive edge.
Cons: You need a credit score of at least 620 to qualify, you need to pay PMI for loans under 20% and/or until the loan is paid down to 78% of the loan to value of the home. PMI is .5% to 1% of the loan amount/year. Only part of your down payment can be a gift if your down payment is less than 20%.
- Jumbo: Loans that are need to purchase a property too expensive for a conventional conforming loan. Not all lenders offer these loans and generally they require larger down payments 20-25%, require higher credit score because these loans are considered riskier to the lender since they can’t be sold to Fannie Mae or Freddie Mac.
Pros: Higher loan amounts are available, in some cases the interest rates are competitive with conventional loans although typically they are higher.
Cons: You need a credit score of at least 700-720 to qualify, often you are required to show cash reserves sufficient to cover 1-year of mortgage payments, documentation requirements tend to be more extensive and often the closing costs are higher.