What you need to know about Conventional Mortgage Loans
So you have been living frugally with the in-laws for way too long and you’ve managed to save up a down payment for a new home. You’ve spent countless weeks, perhaps months checking out neighborhoods to find the ideal home. Perhaps you have found the right home, but not sure what the next steps are. You may have heard the word conventional mortgage thrown around and have no idea what it means or if it is your best option. Before you talk to someone about rates and such there are some basic things to understand.
Here are the questions you should be asking yourself at this stage:
What kind of loan can I qualify for?
What is the total cost of home ownership?
What should my deposit be?
Who do I talk with to get a loan?
Where do I start?
At this point your judgement may be clouded by emotions, when you need to put your emotions aside and be thinking logically about approaching the loan approval process.
The Moreira Team has put together a step by step guide called “Simple Steps To A Conventional Home Loan” with quick answers to all the questions you have and some you may not have thought of yet.
Conventional mortgage loans offer a unique opportunity for borrowers to become homeowners with vary favorable terms. The loan has more strict guidelines than other loan programs but can be more affordable than other loan products. You will often see down payment requirements as low as 5% in most cases.
One thing you need to know about a conventional home loan is that it is not guaranteed by Uncle Sam. There are a few differences from Government backed loans that you need to understand. These loans may be a bit tougher to get and can have more stringent qualifications.
Here are some conventional mortgage loan criteria to review before contacting a Mortgage Professional:
Income – Your monthly mortgage payment, including taxes and fees should not exceed more than 36% of your total income. If you combine this with your consumer debts and car loan this amount ideally should not exceed 43% of your gross monthly income.
Financial History – Your lender will want to look at the past two years of income with proper documentation of salary, including W2’s and pay stubs. If you’re self-employed, your lender may require more documentation such as a profit & loss statement or tax returns. You’ll also be required to provide valid identification like a drivers license or social security card. What it comes down to is proving you have the income you say you do to the lender.
Credit Score – Your credit score or FICO score plays a major part in the decision process of the lender. In most cases your credit score should be 620 or above. If your credit score falls below this you may have a difficult time acquiring this type of loan.
Down Payment – The customary down payment required for a conventional loan is 20% of the cost home. If for some reason you’re unable to come up with the 20% you can take on a loan with as little as 5% down, but you will be on the hook for mortgage insurance which can add more expense to your overall cost of home ownership in the loan. Luckily there are options that offer no monthly mortgage insurance even with less than 20% down. Your credit score will have to be higher to qualify but can provide you a lower fixed payment overall per month. Speak to your licensed mortgage advisor to get all the details on this Lender Paid Mortgage Insurance option.
Home Price – The amount you want to finance will play a role in whether your financing gets approved or not. Freddie Mac or Fannie Mae loans have a cap of $417,000 in most counties. This is where a Mortgage Broker shines because they can find the right loan product that will allow you to take on a non-conventional loan with a higher home price that exceeds what Freddie Mac or Fannie Mae limits. Jumbo Loans can address this need, but again the more Mortgage you take on the tighter the guidelines and qualifications can become so talk to a licensed mortgage advisor to find the right loan product that you can realistically take on.
Getting the best interest rates
At this point you’ve pre-qualified yourself for the mortgage you want and now you want to know the right mortgage that fits your needs.
Fixed Rate Mortgages
If this is a home that you expect to live in more than 5 years you should be considering a fixed rate mortgage that can range from 30, 25, 20, 15 or even 10 year term periods. For most people in this current mortgage rate climate of low interest rates many are locking into a fixed mortgage. The beauty of a fixed mortgage is you know your mortgage payment will be the same for the life of the loan.
Adjustable Rate Mortgages
These mortgages have great low rates but add a bit of risk since if the interest rates should rise at the time of reset your payments will increase and your total cost of home ownership will go up accordingly. If you know that you may not be living in your home for more than 5 years it could be the right option for you to lower your mortgage payments because you would have a lower rate than a traditional Fixed Rate mortgage.
There are currently three main types of Adjustable Rate Mortgages:
The interest rate is a low teaser rate at signing and then gradually increases based on the agreed upon terms.
Interest Rate Only
You only pay the interest each month for the specified time period you select with the lender then it switches over to principal and interest when this agreed upon time elapses.
These usually show up as 3/1,5/1,7/1 or 10/1. This means they are fixed for 3,5,7 or 10 years and then adjust every year after the specified period of time you negotiate with the lender.
A few things to consider before signing ARMs:
Starting interest rate – The initial rate at signing
Adjustable period – This is when your loan moves from being fixed to variable.
Index: The cost of the mortgage lender to borrow the money. You should choose a slow changing index like (COFI) because as your lenders rate climbs so does yours.
Life-of-the-loan cap: This is the highest interest rate your mortgage can go up to.
Periodic cap: This limits how much the interest can adjust in a one year period
Low margin: This is the mortgage lenders profit margin which is usually around 2.75 percentage points.
Prepayment penalty: A penalty for paying your mortgage off early, and is usually around six month’s worth of mortgage payments. There should never be a penalty for paying off your loan sooner than expected.
Regarding interest rates there are three areas that you need to consider:
The base interest rate – The rate the mortgage professional secured for you with the lender.
The Annual Percentage Rate (APR) – The total cost of your loan including closing fees that are divided over the number of years of your loan. This rate is higher than the base interest rate which your mortgage payment is attached too..
The lifetime cost of the loan – That big number that looks scary on paper, basically how much you will pay over the term of the loan for principal and interest. (30 years as an example).
What Should I Do If I Fall Behind On A Conventional Loan?