In the world of lending, there are countless factors involved in obtaining a home loan. This article will give you an overview of the three main loan programs available. When you start looking at loan programs, be sure to contact a mortgage professional for more information and the latest market updates and changes.

FHA Insured Loans

An FHA loan is a loan insured by the Federal Housing Administration. The FHA was created in 1934 to increase home construction and reduce unemployment through loan insurance, which essentially reduces risk for lenders making the loan. During tough real estate times, FHA loans step into the spotlight and become more important because they allow homeowners to obtain loans often at lower rates and with better terms than conventional loans. However, when times are good and investors are willing to take higher levels of risk (boom of 2005), conventional loans will offer the most attractive terms for homebuyers.

In today’s market, conventional loans often require 5-10% of the purchase price as a down payment and don’t offer the most competitive interest rate. Due to the government-insured aspect, FHA loans can have down payments as low as 3% and will allow the seller to contribute (give) up to 6% of the purchase price of the home to the buyer to help them move. At the time of this post, the government is talking about increasing the down payment amount and getting rid of the seller support aspect. Changes made to FHA loans often reflect moves to ensure homeowners can move into their home and make payments over long periods of time, creating a more stable housing market.

Conventional Loans

Conventional loans are not guaranteed or insured by the government and therefore do not meet the same strict guidelines as FHA loans. A traditional conventional loan requires the homebuyer (borrower) to put down 20% of the purchase price and the remaining 80% will be financed as a conventional loan. Because the buyer is putting down such a large amount, these loans are often considered low risk and do not require any type of insurance.

In recent years, conventional loans have evolved to meet the needs of homeowners with very little to put down in a home. In this scenario, the buyer would come in with less than a 20% down payment and would have one of two options. Here is an example to explain the options.

Mr. and Mrs. Homebuyer decides to buy a home for $100,000. A traditional conventional loan would have buyers put up $20,000 for a down payment and the remaining $80,000 would be financed/mortgaged. Now, if the buyer only had a $10,000 down payment, these are the two options they could choose from.

Option 1: Get a large loan for $90,000. Because the buyer would be financing more than 80% of the home’s value/purchase price with the first loan, the buyer would pay for Private Mortgage Insurance, or PMI. This insurance protects the lender who writes the loan in case the buyer defaults on their loan. The theory is that the higher the loan-to-value ratio (amount borrowed against the home’s value), the less invested the buyer is and the more likely they are to default for whatever reason.

Option 2: As a way to avoid paying PMI, the borrower can obtain two loans. The first loan would be for $80,000 and the second loan would be for $10,000 with the remaining $10,000 going towards a down payment. Because the first loan has a loan-to-value (ltv) ratio of 80%, there would be no premium insurance (PMI). The problem with this loan is that you will most likely pay a higher rate on the second loan of $10,000. Instead of paying for mortgage insurance, the borrower would pay a higher premium for the second loan. The higher interest rate is the lender’s way of justifying the risk of the second loan.

The second option is how many homeowners ended up 100% financing their home and stretching their financial limits too far.

VA Guaranteed Loans

VA loans are guaranteed like FHA loans, but the Department of Veterans Affairs handles the guarantee. VA loans were created to help veterans buy or build homes for eligible veterans and their spouses. VA also guarantees loans for the purchase of mobile homes and land on which to locate them. A veteran who meets any of the following criteria is eligible for a VA loan:

• 90 Days of Active Duty for Veterans of World War II, the Korean War, the Vietnam Conflict, and the Persian Gulf War
• A minimum of 181 days of active duty during the periods of interconflict between July 26, 1947 and September 6, 1980
• Two full years of service during any period of peacetime since 1980 for enlisted men and since 1981 for officers
• Six or more years of continuous service as a reservist in the Army, Navy, Air Force, Marine Corps, Coast Guard, or as a member of the Army or Air National Guard.

There is no VA dollar limit on the loan amount a veteran can obtain, the limit is determined by the lender. To determine how much of a home loan the VA will guarantee, the veteran must request a certificate of eligibility.

Bottom line

Just as the real estate industry is continually changing, the mortgage industry is also evolving on a daily basis. The general rule of thumb for both industries is that 50% of what you know today will be outdated and useless in three years. This emphasizes the importance of discussing your needs with a qualified loan officer who is continuously trained and abreast of the market.