The majority of mortgage loans made in the conventional loan market adhere to the underwriting guidelines of Freddie Mac and Fannie Mae for conforming loans. Conventional loans are by definition “conforming” if they are generally $417,000 or a lesser loan amount for a single-family residence. Conforming loan limits are designated by area and can reach up to $625,000 in some states such as Hawaii and Alaska, but for the most part $417,000 is the most wide-spread conforming loan limit. Conventional loan limits greater than $417,000 are considered “nonconforming” loans, or jumbo, and the interest rates are normally substantially higher.
Conventional loans through Freddie Mac and Fannie Mae have established guidelines, or pricing tiers, for borrower credit scores, loan-to-value ratios, minimum down payments, and income requirements. For instance, most conventional mortgage purchase loans require a minimum 3% to 20% down payment range and allow for a 100% gift from blood or by-marriage relatives. Two of the most important factors when purchasing a home with a conventional loan are the term of the loan and loan-to-value ratio (LTV), or down payment amount:
- 97% LTV with a 30-year term
- 95% LTV with a 30-year term
- 90% LTV with a 30-year term
- 85% LTV with a 30-year term
- 80% LTV with a 30-year term
The term of the loan can vary from longer or shorter depending on the borrower’s preference and ability to qualify. A shorter-term mortgage will typically result in a lower interest rate.
There are a number of benefits in refinancing to a conventional mortgage. Normally, conventional mortgages offer lower interest rates than most other loan programs. This is primarily the result of wholesale lenders’ ability to bundle these loans and sell them in the secondary market. Accompanying the bulk sales of mortgage loans is the reduced credit risk conventional loans can offer lenders because of larger down payment requirements. A rate and term conventional refinance is presently limited to a maximum 97% loan-to-value, whereas a cash-out conventional refinance may not exceed an 80% loan-to-value ratio. Unless the homeowners have more than 20% equity in the property, the borrower is required to pay private mortgage insurance, which is an additional monthly cost added to the traditional mortgage payment.
- Mortgage Insurance
Any loans with loan-to-value ratios greater than 80% are subject by the lenders to carry a private mortgage insurance policy. Please see our Mortgage Insurance Options page for further details and choices on this topic. Private monthly mortgage insurance can be eliminated on a conventional loan. However, the process and requirements to cancel private mortgage insurance can vary between lenders.
- Credit Score
Presently, conventional guidelines are changing quite frequently. A minimum FICO score requirement for a competitive interest rate is higher than those required for an FHA loan. The borrower currently needs a minimum 640 credit score to qualify for a conventional loan and any credit score below a 740 is subject to the lender adding fees, which can be sizable, as in the several-percent range, as a borrower’s credit score drops compared to loan-to-value ratios.
- Interest Rate Pricing
On the contrary, borrowers with excellent credit scores over 740 and loan-to-value ratios under 80% are eligible for lower interest rate pricing and lender credits. These lender credits are used to lower the interest rates and/or as subsidies towards lowering the overall cost of the loan transaction. As the loan-to value ratio decreases (as low as 60% LTV), or inversely as the equity increases (up to 40%), the more favorable the interest rate pricing becomes.
- Adjustable-Rate Mortgage
Conventional loans incorporate either a fixed or adjustable interest rate program. Under standard market conditions, adjustable-rate mortgages (ARMs) usually result in a lower interest rate for the shorter fixed term of the loan. Once the initial fixed period has expired, the ARM’s interest rate fluctuates in relation to customary financial indexes, such as the COFI or LIBOR. The new variable rate allows the monthly mortgage payments to rise or fall according to the loan’s base rate, plus the index.
Conventional loans are ideal for borrowers with exceptional credit and who can meet the expense of a more sizable down payment.
Jumbo loans are mortgages that are larger than the standard loan size. Because jumbo mortgages exceed the “conforming” loan limit of $417,000, the maximum loan amount documented for purchase by Fannie Mae and Freddie Mac, these loans are considered “nonconforming” loans. Most jumbo loans are presently originated with big banks that intend to keep the mortgages on their books instead of selling the loan on the secondary market.
- Basic Qualification
Initiating in 2007, a massive credit squeeze and falling property values began to scare banks away from lending in the jumbo market. Jumbo loans have made a gradual comeback, but with much tougher guidelines. To qualify for a jumbo loan in this lending environment, the borrower can expect to meet at least the following credentials:
- Contributing a down payment of at least 20% for a purchase (in some rare situations a bank may allow 15% down payment) and in some cases exceeding 30%.
- A down payment of 25% is generally adequate and will yield the lowest interest rates.
- With virtually no exceptions, lenders require borrowers to have credit scores or 720 or better (minimum score depends on type of dwelling and loan amount). A 760 credit score or above is more favorable.
- Debt-to-income ratio (DTI) is usually limited to 38%, meaning that total monthly liabilities cannot exceed 38% of total gross monthly income (before taxes).
- Fully document two years of consistent income history.
- Maximum loan amount for 1-2 units of $2 million.
- Adjustable-Rate Mortgage
These nonconforming so called “portfolio” loans epitomize the back to basics old-fashioned lending style, in which institutional lenders make profits by charging higher interest rates on lending than they pay on their consumers’ deposits. The past few years, interest rates paid to customers on deposits are historically low, but they will rise someday. Banks tend to benefit from jumbo adjustable-rate loans (ARMs) when rates rise after the initial fixed period. The interest rates on jumbo ARMs will rise with the rates paid on consumer deposits. Therefore, jumbo ARM products are priced more favorably than most fixed-rate products.
The most popular loan for a jumbo mortgage is currently the 5/1 ARM, which possesses an introductory fixed-rate for the first 5 years of the loan amortization and then adjusts annually with protective caps thereafter.
Because jumbo loans are primarily portfolio mortgages, refinancing guidelines are similar to purchase guidelines for owner-occupied homes. Loan-to-value and credit score requirements have a wide-range variance between lenders. For example, a rate and term refinance will generally limit the loan-to-value to 70% or 75% loan-to-value. Cash-out refinance loan-to-value and credit score stipulations are likely even more conservative.
With a less standardized jumbo lending environment, it pays to use a broker to shop for the best jumbo loan as these types of mortgages are no longer market commodities.
FHA Streamline Refinance
FHA has permitted streamline refinances on insured mortgages since the early 1980s. “Streamline refinance” refers only to the amount of documentation and underwriting that the lender must perform, and does not mean that there are no costs involved in the transaction.
The basic requirements of a streamline refinance:
- The mortgage to be refinanced must already be FHA insured.
- The mortgage to be refinanced should be current (not delinquent). The borrower can have only 1 mortgage late in the last 12 months. Also, the borrower must have 3 months of no late history on any debt.
- The refinance results in a lowering of the borrower’s monthly principal and interest payments, or, under certain circumstances, the conversion of an adjustable rate mortgage (ARM) to a fixed-rate mortgage. The loan has to qualify for a net tangible benefit. Net Tangible Benefit is defined as reducing the (principal + interest + mortgage insurance) component of the mortgage payment by 5 percent or more.
- No cash may be taken out on mortgages refinanced using the streamline refinance process.
- The FHA requires that borrowers make 6 mortgage payments on their current FHA-insured loan, and that 210 days pass from the most recent closing date, in order to be eligible for a Streamline Refinance.
- The borrower will continue to pay a monthly mortgage insurance premium and an up-front mortgage insurance premium. This is determined by the following: 1. Homeowners whose new loan replaces an FHA-backed mortgage prior to June 1 2009 may pay a lower monthly premium and lower up front premium. Contact us for actual amounts.
1. Homeowners whose new loan replaces an FHA-backed mortgage prior to June 1 2009 may pay a lower monthly premium and lower up front premium. Contact us for actual amounts.
2. Homeowners whose new loan replaces an FHA-backed mortgage after June 1 2009 may pay a higher monthly premium and higher up front premium. Contact us for actual amounts.
Mortgage Insurance may be canceled depending on when you obtained your FHA loan and what loan to value you had at time of closing.
Benefits and Qualifications of the Streamline Refinance:
- FHA Streamline Refinances are the fastest simplest way for FHA-insured homeowners to refinance their respective mortgages.
- The FHA Streamline Refinance program’s defining characteristic is that it does not require a home appraisal. Instead, FHA will allow you to use your original purchase price as your home’s current value, regardless of what your home is actually worth today.
- Employment and income are not verified. FHA does not require verification of a borrower’s employment or annual income as part of the streamline process. No paystubs, w-2s or tax returns are required for approval.
- Credit scores are not verified. The FHA does not verify credit scores as part of the FHA Streamline Refinance program. The payment history is used as a gauge for future loan performance.
- Loan balances may not increase to cover loan closing costs. The new loan balance is limited to this formula (Current Principal Balance + Upfront Mortgage Insurance Premium). All other costs may be paid for by the borrower in cash or at closing or by a credit from the lender in full. This would be considered a No Cost Loan.
The Federal Housing Administration (FHA), which is a part of HUD, insures this loan so the lender can offer a more competitive deal. This type of loan is popular among first-time home buyers. However, being a first-time buyer is not a requirement. FHA loans are normally restricted to a primary residence and only one FHA loan per person, unless the borrower or borrowers can prove that their family has outgrown the current residence or if an employment relocation is taking place. Either way, these circumstances are up to the lender and underwriter’s discretion.
FHA’s minimum requirement for down payment for a purchase is 3.5% or $3,500 on a sale price of $100,000. Technically, FHA does not require a minimum credit score; however, lenders have what are called “lender overlays”, which usually require a credit score of at least 640. Other conditions can apply to credit scores down to 500. FHA programs come in a large assortment (e.g., 30-year, 30-Year 2/1 Buydown, 15-Year, 3/1 and 5/1 ARMs).
The advantage of doing an FHA 15-Year loan with 10% down payment or equity is that the consumer may not have to pay monthly mortgage insurance. This may change with new rules in 2013. All Conventional loans require a 20% down payment to eliminate mortgage insurance.
On a 30-Year fixed loan with 3.5% down payment, FHA requires that you pay a monthly mortgage insurance fee. Worth mentioning is that the mortgage insurance fee factor will decrease with a 5% plus down payment. Loan amounts are restricted to county loan limits, which vary from state to state.
Per FHA guidelines and in addition to the monthly mortgage insurance, the borrower or borrowers will pay an upfront mortgage insurance fee. This fee can be financed or paid in cash, but this means that interest on that fee is paid over the term of the loan.
With Conventional loan programs, the borrower or borrowers can appeal to have the mortgage insurance removed once the property’s loan-to-value ratio reaches 80%. With FHA mortgages, depending on when you closed your FHA loan, the mortgage insurance premium may apply for the life of the loan.
- FHA Refinance
When refinancing with FHA, you may refinance up to 97.75% loan to the value of the home. You may only receive up to $500 cash back at closing. This is called a Rate-and-Term Refinance. The new loan can only refinance the existing FHA-insured first lien, closing costs, and prepaid expenses. You must obtain an appraisal on this loan. You will also pay monthly mortgage insurance and an up- front mortgage insurance premium when you do a refinance. Although, you may be eligible for a refund of a portion of your original up front mortgage insurance premium paid at the time you last refinanced or purchased. Qualifications are similar to when your purchased your home.
- Streamline Refinance
If you have paid at least 6 payments on your mortgage and it’s been more than 210 days, you may qualify for a Streamline Refinance. The Streamline Refinance, which does not require an appraisal, has far less stringent requirements. Visit our streamline refinance page for more detailed information.
- Cash Out Refinance
If your property was purchased more than one year prior to the refinance, you can refinance the existing mortgage up to 85 percent of the appraised value plus the allowable closing costs, which may vary from state to state.
This special program allows a potential buyer to purchase a Fannie Mae-owned property with a down payment as low as 3 percent, funded by the borrower’s own savings, a grant, a gift, or a loan from a nonprofit organization. HomePath mortgages are eligible as primary residences, second homes, and investment properties. Possibly the largest incentive for the HomePath program is the mortgage does not require a property appraisal, mortgage insurance premium, or monthly mortgage insurance. Seller contribution limits are expanded for closing costs allowed. Additionally, HomePath offers renovation mortgages. For more information, and to search for Fannie Mae-owned eligible homes, please visit HomePath.com.
The VA Home Loan program is backed by the U.S. Department of Veteran Affairs. This program allows veterans, with qualifying income and credit, to purchase a primary residence without putting any down payment funds towards the sale price of the home, as long as that sale price does not exceed the appraised value of the property. There is no maximum VA loan amount; however, lenders will generally limit VA loans to the county’s Conforming loan limit of $417,000. For loans up to this limit amount, it is typically possible for qualified veterans to obtain no down payment financing. A veteran’s maximum entitlement is $36,000 (or up to $104, 250 for certain loans over $144,000). Lenders will usually loan up to 4 times a veteran’s available entitlement without a down payment, provided the veteran’s income and credit qualify, and the property appraises for the sale price. Additionally, VA loans require no mortgage insurance premiums and monthly mortgage insurance fees. Be aware that VA also requires a funding fee that can range between one and three percent depending on current guidelines. This can be rolled into your loan amount or paid in cash at time of refinance or purchase.
USDA Rural Housing
The Rural Housing loan is guaranteed by the USDA’s Rural Housing Service. This mortgage program is designed for low to moderate income families in rural areas. The USDA’s “guarantee” means that they will compensate any lender for any USDA Rural Housing loan in default. Additionally, this “guarantee” means that lenders are more than willing to lend their money to individuals with less than stellar credit and no down payment requirement. Most lenders will allow credit scores as low as a 620. The “guarantee” also indicates that lenders will not require mortgage insurance for Rural Housing loans. Nonetheless, Rural Housing loans charge a 3.5% upfront funding fee, which can be financed into the loan. In the scenario of financing the funding fee, the final loan amount will equal 103.5% of the property purchase price. This means the consumer begins homeownership with a mortgage larger than the home is worth. The two major limitations of this program are income restrictions and the property must be located in a designated rural area. Please go to the USDA’s website to check income and property location eligibility.
Adjustable Rate Mortgages (ARM)
When it comes to ARMs there’s a basic rule to remember…the longer you ask the lender to charge you a specific rate, the more expensive the loan.
2/1 Buy Down Mortgage
The 2/1 Buy-Down Mortgage allows the borrower to qualify at below market rates so they can borrow more. The initial starting interest rate increases by 1% at the end of the first year and adjusts again by another 1% at the end of the second year. It then remains at a fixed interest rate for the remainder of the loan term. Borrowers often refinance at the end of the second year to obtain the best long-term rates. However, keeping the loan in place even for three full years or more will keep their average interest rate in line with the original market conditions.
This loan has a rate that is recalculated once a year.
With this loan, the interest rate is recalculated every month. Compared to other options, the rate is usually lower on this ARM because the lender is only committing to a rate for a month at a time, so his vulnerability is significantly reduced.