• November 23, 2014

Which mortgage is right for you?

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Posted: Sunday, September 22, 2013 4:30 am

FHA, Fannie Mae, Freddie Mac, VA. Conforming, high-balance conventional, jumbo, super jumbo.

The options for mortgages include a plethora of acronyms and jargon, with each choice representing its own set of trade-offs. How do you decide what is right for you?

“It’s not easy for even experienced homeowners to know all the pieces that go into a mortgage. If it’s the first time you’re doing it, it can be very daunting,” said Joe Rogers, an executive vice president at Wells Fargo in Columbia, Md. “You might end up with a loan that would be okay, but it might not be the best one for you.”

To make the right choice, start by understanding your objectives, what types of mortgage you qualify for, and the benefits and limitations of each option when it comes to a home loan. For instance, a Fannie Mae mortgage allows a smaller down payment as a percentage of your loan, but you can’t borrow as much compared with a mortgage that a bank will hold in its portfolio.

“Educating oneself is really important,” said Bob Walters, chief economist for Quicken Loans. “Talk to a couple of mortgage bankers until you feel comfortable with one. That’s going to be the best source of information.”

With recent headlines about jumbo mortgage rates reaching unprecedented lows, you may think that a low rate is the key. But you should consider a combination of elements in addition to the rate, including limits on the size of the mortgage, the amount of down payment, mortgage insurance costs, your credit rating and any additional fees that will be included in the closing costs. “There are a number of factors that will determine what program” suits you best, Walters said.

Before you start looking seriously at potential homes to buy, evaluate and compare the mortgage options. Obtain a pre-approval letter so you’ll be prepared to make a strong offer when you fall in love with a house.

“If you know in advance what you have available, it gives you more authority and competence when you’re out seeing houses and making an offer,” Rogers said. “When you’re making a decision around the house, you shouldn’t jerry-rig the financing to fit that.”

VA mortgage

If you qualify, the original no-down-payment mortgage that the Veterans Affairs Department offers to military veterans is often a winning choice. Rates are low, some closing costs may be financed and you generally can borrow without a down payment. When Rogers makes presentations to Wells Fargo home mortgage consultants, he emphasizes that they should explore a VA mortgage.

“What are the first four words you should say to any customer?” he asks them. “Are you a veteran?”

VA loans aren’t technically limited in size, but if you need to borrow more than $417,000, you may need to put down some money depending on where you are buying in the region.

And even above that limit, the VA down payment will still be small compared with other mortgage options: For a $1 million property, you’d put down $39,100, he said. Credit quality doesn’t affect your interest rate with VA loans the way it would with conventional financing. All VA borrowers pay a one-time funding fee for the VA guarantee.

If your goal is to put as little money down as possible and you haven’t used your veterans’ mortgage benefit, or had your eligibility reinstated, this most likely will be the best choice.

FHA mortgage

During the housing crisis, the government stepped into the mortgage market to guarantee more than 90 percent of the mortgage volume. As part of the Obama administration’s strategy to reduce this government support, policies for Federal Housing Administration mortgages are getting stricter and costs are rising.

“They’ve had to increase both their upfront and mortgage insurance premiums dramatically,” Rogers said. “FHA’s MIP has gotten quite expensive.”

You’ll be paying that mortgage insurance premium for the life of the loan, unlike mortgages that conform to Fannie Mae and Freddie Mac standards. Homeowners with a Fannie or Freddie mortgage can cancel the insurance after the balance on the loan falls to 80 percent of the home value, known as the loan-to-value ratio. That can happen through a rising market or by paying down the principal balance.

As a result, even though it’s appealing to surrender only the 3.5 percent required as a down payment for FHA loans, you might be better off saving up the additional 1.5 percent to qualify for a conventional mortgage with better rates, lower mortgage insurance fees and lower closing costs. In addition, the FHA takes more time with the appraisal, home inspection and closing — a delay that could hurt you in a competitive sales market.

On the plus side, unlike traditional borrowing, if your credit isn’t stellar, FHA won’t penalize you by raising your interest rate.

Technically, your FICO score could be as low as 580, although practically, most lenders require at least 620, said Keith Gumbinger, vice president at HSH.com, a mortgage information Web site.

“FHA offers you some very liberal underwriting standards that come in exchange for you having to pay mortgage insurance,” he said. “There is going to be more paperwork, the process is going to be slower and more exacting, but you can achieve a much better interest rate if your credit score is poor.”

Conforming mortgage

The most common mortgage is a conforming conventional loan, which means that it meets the standards set by Fannie and Freddie. Banks can sell these loans to Fannie and Freddie, which then package them together and sell them to investors. They charge a guarantee fee estimated at 0.5 percent that is added to your rate.

Typically, you need a 5 percent down payment and good credit to qualify for a conforming mortgage. You can borrow as much as $417,000.

“Conventional financing has higher requirements with regard to credit scores and debt-to-income levels,” Rogers said. If your credit is borderline, especially if you have a low down payment, you will pay more in the form of higher rates. This is known as loan-level price adjustments assessed by Fannie or Freddie.

A conforming loan isn’t always sold to Fannie or Freddie. Some banks hold conforming mortgages in their portfolios, in which case they may be more competitive with rates, he said.

High-balance conforming mortgage

Similar to a conforming conventional mortgage, a high-balance conforming loan can be purchased by Fannie and Freddie. The difference is that the maximum loan amount rises in steps to a limit of $625,500 depending on where you live.

In exchange for the larger loan volume, be prepared to put down 10 percent to 20 percent and demonstrate through income and credit scores a greater ability to repay.

“For a while, it was hard to get a Fannie/Freddie loan with less than 20 percent because mortgage insurers wouldn’t write policies. They couldn’t afford to insure a property in a market where prices were still declining,” Gumbinger said. “We’ve come not full circle, but mortgage insurers are certainly healthier, writing more policies with less of a down payment and taking on more risk. That’s opened up credit over the last year.”

If you have excellent credit and a large down payment, you can lower your rate as much as 1¼ percent. Once you pay down your mortgage to 80 percent or rising home values get you to that threshold, you can request to cancel your mortgage insurance.

For most buyers with decent credit and money for a down payment, this is the best mortgage choice. You also may have an advantage in a fast-moving real estate market, in which sellers may consider FHA or VA financing a disadvantage.

Reese Goldsmith and her husband, Larry Mosley, qualified for an FHA mortgage but after losing several houses to competing buyers with traditional financing, they switched to a conforming mortgage.

“We were losing so many homes by doing FHA financing,” said Goldsmith, who ended up buying a three-bedroom house in Washington. “Really understanding our financing was definitely an issue for us.”

Jumbo mortgage

If you want a single mortgage larger than $625,500, the only choice is a jumbo loan. Rates are typically higher, but in recent weeks, they have fallen dramatically. This flip-flop is the result of growing interest in jumbo mortgages from banks and private investors, and the market expectation that the Federal Reserve will reduce its purchases of bonds. Many data sources show jumbo rates higher than conforming ones, but at least one — the Mortgage Bankers Association — reports that jumbo rates are lower than conforming for the first time in history.

As a result, borrowers who are on the border of the jumbo borrowing amount may want to evaluate whether taking a larger loan will result in lower costs.

Jumbo borrowers need to put more money down, have excellent credit and go through a rigorous documentation and underwriting process. Most jumbo products require a credit score of 700 or 720 and a down payment of 20 percent to 40 percent, Walters said.

If you can’t afford a down payment that large, you might instead take out as much as you can with a high-balance conforming loan and borrow the rest as a home-equity line of credit.

Find banker you trust

Whatever you end up choosing, you’re better off with the guidance of a mortgage banker you trust, who will walk you through the trade-offs. You can learn a lot on the Internet, but ultimately, a conversation with a professional lets you compare products tailored to your situation.

“Find a person who is asking you a lot of questions about what your situation is to find out the best choice for you, rather than just quoting you a rate,” Walters said. “It can be frustrating at first when somebody is asking a lot of questions. That tells you you’re dealing with a professional. You wouldn’t want to go to a doctor who didn’t examine you, and just said, ‘How do you feel?’ and wrote you a ‘scrip.’”

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