There are basically two buckets that mortgage loans fall under: government and non-government loans (a.k.a. conventional loans).
Government loans are loans that are backed by the United States government. The three departments are the:
- Housing and Urban Development (HUD),
- Veteran’s Administration (VA),
- United States Department of Agriculture (USDA).
The government is on the hook to make the lender whole should the loan result in a foreclosure. Government loans typically have some form of Mortgage Insurance (a.k.a. MI, MIP, PMI, Funding Fee, etc.).
The interest rates for these programs tend to be very reasonable even when layers of risk exist.
FHA Home Loans
FHA is not exclusive to first-timer buyers though is often dubbed as such. FHA is typically used for lower credit scores and/or lower down payment options. The minimum down payment is 3.5%.
FHA MI is expensive compared to conventional MI. The upfront MIP is 1.75% and monthly is as high as .85%. MI is permanent if the down payment is less than 10%; after 10% it takes 11 years for the MIP to drop off.
FHA loan limits vary from county to county. The loan limits can be looked up on the HUD website.
Technically Reverse Mortgages fall under FHA (i.e. HUD) and are exclusive to homeowners of 62 years or older.
Reverse Mortgages can be structured in a varity of ways. For example:
- no monthly payments,
- lump sum payment amounts,
- lines of credit,
- or with monthly installments.
The highest LTV is typically around 50% so a client better have a ton of equity. The LTV directly correlates with the homeowner’s age. The older the homeowner the more equity they can access.
Reserve Mortgages are often a “need based” loan. They can be relatively costly depending on loan amount. Points range from $2,500 to $6,000 depending on the loan size.
Upfront MIP is like FHA at 1.75% and it does have monthly MI despite the lower LTV.
Reverse Mortgages fit a very small minority but are great options for those that truly need it.
Veteran Administration (VA)
VA loans are for veterans (or surviving spouses of veterans). VA allows zero down payment with two exceptions:
- If a borrower has an existing VA loan at the time of the new closing. The Vet won’t have full entitlement so they’ll have to put some money down.
- If the purchase price is above the conforming loan limits they’ll have to put some money down.
In both cases the lender will use a VA worksheet to determine the down payment amount.
VA loans don’t have any monthly MI but there is a Funding Fee (which is basically like an upfront MIP charge). The funding fee typically ranges from 1.5% to 3.3% of the loan amount.
The funding fee can be waived if the borrower has enough disability from the VA.
Property taxes can even be waived with enough disability from the VA. The amount of the tax exemption varies by county and depends on the amount of the veteran’s disability.
USDA Home Loans
USDA home loans offer 100% financing when the property and the buyer both qualifies. USDA is for homes in more rural areas and the house must be located in an eligible area.
See USDA’s Eligiblity Map for details.
Another qualifying factor is that there are income limitations. In most areas that typically caps out around $80k-$85k per year of household income.
Like other government loans there is an upfront MIP as well as monthly MI that is required.
Conventional mortgages are basically any loans that don’t fall under the government bucket.
Often times “conventional” and “conforming” are incorrectly interchanged. “Conventional” means a non-government-backed loan. “Conforming” just means it’s a conventional loan that has a loan amount within Fannie Mae and Freddie Mac’s eligible loan limits.
Conforming loans are conventional loans that meet Fannie Mae and Freddie Mac guidelines.
We typically recommend Mortgage Down Payments in 5% intervals because that’s when MI factors change. After 20% down there is no significant benefit to putting more money down outside of just lowering the loan amount to achieve a particular payment. The minimum down payment with a conventional loan is 3%.
Mortgage Insurance (MI) is required when the LTV exceeds 80%. MI can be avoided with Split Financing (i.e. a first and second mortgage).
Another option to avoid the monthly payment of MI is to do upfront single paid MI that’s either: paid by borrower at closing, rolled into the loan amount, or roll into rate (which is called Lender Paid MI).
A homeowner can Cancel MI under certain conditions. The generic answer for MI removal is 80% LTV after two years of payments.
A Jumbo Loan is a conventional loan where the loan amount is above the conforming loan limit.
Jumbo interest rates may be a pinch higher than conforming rate. Jumbo rate are typically about .125% to .375% higher depending on credit and loan amount. Occasionally the jumbo rates can at parity or even lower than conforming rates.
Many folks do 10/1 ARM instead of 30 year fixed because of rate differential (.375% to .5%).
“Normal” mortgage folks can typically do loan amounts up to $2MM. Loans above $2MM typically go to portfolio loans.
A portfolio loan is a loan made by a financial institution that underwrites to it’s own guidelines and plans on keeping the mortgage. (Remember servicing a loan does not mean they actually keep and own the loan).
Since portfolio lenders keep the mortgage they make rules and allow for exceptions. The programs are traditionally ARMS with higher rates and require 20% down. Some programs do offer less than 20% down but there’s a premium in the rate.
Most of the time portfolio products are used for loans when income doesn’t fit inside the normal box.
There are many types of bond programs and many allow 100% financing. Most will have some type of income cap and some have geographic or employment restrictions. These programs can be expensive with their MI, points, and higher rates.
Cash Out Loans
Texas Cash Out home loans are unique because Texas is the only state that has it’s own (more restrictive) laws for equity loans. The technical term is a “Texas A6”; the article of the Texas Constitution that outlines the parameters.
Texas A6 equity loans can be done a “normal” first liens or as a second liens. Interest rates for cash out loans in Texas typically have .125% to .25% higher interest rate than a “normal” rate and term refinance.
There an only be one A6 loan on a home.
Texas A6 Cash Out
As mentioned a Texas A6 cash out home loan is unique and has it’s own set of guidelines. The most prevalent is that LTV is limited to 80% of the home’s value. Another nuance is that an A6 can’t be refinanced for one year after closing.
There is a 3% cap on closing costs which creates challenges on smaller loan amounts. Example: if there are $3,000 of fixed costs in a loan PLUS a title policy, and someone wants a $100,000 cash out loan amount, the lender will either have to “eat” the title policy (which could be $800-$900) and therefore increase the interest rate to the consumer to recoup those costs.
See all the guidelines on the Texas 12-day Letter.
A Home Equity Line of Credit (HELOC) is typically done by banks and they are second liens with variable rates (ex: Prime + .5% up to 2%). The costs are typically $500 + Appraisal ($500). 20 year loan term but the first 10 years are interest only payments with the line only available for the first 10 years, this is good option for money that’s needed for the short-term (i.e. few years). This is also a great financial safety net because a zero balance means zero payment so it’s a handy lifeline when needed. FYI, HELOCs are limited to 50% of the homes value and very few banks will go above $150-200k. There are a few banks that will offer up to $500k. Call your favorite lender with a Financial Advisers Mortgage Cheat Sheet to discuss.
Second Lien Cash Out (A6)
A second lien cash out home loans are done by banks. Like HELOC the costs are minimal, but unlike HELOCs these are fixed rate mortgages. The rates can be 1.5% to 3.5% points higher than a “normal” first lien mortgage depending on credit and amortization schedule. Most banks will offer terms in five year increments starting at 5 years and going up to 20 years. In rare cases some banks will offer 30 year fixed.
Home Improvement & Construction
When it comes to home improvement loans HomeBridge Financial is ranked #1 in the country in volume for first-lien renovation loans. Gloating aside, when a loan amount venture into the jumbo realm (i.e. goes above $424,100) it’s often times makes more sense for them to do something with a local bank. This Financial Advisers Mortgage Cheat Sheet has more below.
Note: the LTV for home improvement loans and construction loans will be based off the ARV (After Repair Value). Banks calculate their ARV differently so we’re not going to list them on this Financial Advisers Mortgage Cheat Sheet.
The After Repair Value (ARV) should be considered initially when doing a home improvement to ensure the house isn’t accidentally over improved for the area. To pay for a home improvement the homeowner can pay cash (obviously), get some type of A6 equity loan, or get a home improvement loan. The A6 option can be challenging if they don’t have enough equity in their current home.
There are two primary options for doing home improvement loans: 1) do one single first lien (which could mean refinancing their existing mortgage), and 2) keep their current mortgage in place and go get Home Improvement Second Lien. A primary consideration on which direction depends greatly on what their existing mortgage terms are. If they have a killer rate then we’ll most likely recommend a second lien. It’s a matter of calculating the blended rate, factoring costs, and discussing objectives to determine what’s best.
Construction loans are two one of two ways, either with a single closing or as two separate loans. Costs are about the same for both and most of the time when the loan amount is above $424,100 (i.e. conforming limits) we’ll recommend the two-time close and recommend the client to a local bank for interim construction financing. The reason is because it gives the client more options to shop the rate when it comes time for the permanent loan as opposed to being beholden to the One Time Close lender.
One Time Close (OTC)
A borrower can do a single transaction where the interim construction loan and the permanent financing take place upfront with a single closing. This is call a One Time Close (OTC). There is major marketing behind One Time Close (OTC) program and I’m typically not a fan. My preference is to go to local bank and get interim loan then refinance with a “normal” mortgage lender for the permanent once the home is built.
- OTC Advantages: rate is locked up front but typically an ARM (7/1 or 10/1) but can be a fixed (rarely a 30 year) and the rate has a small premium. Cool part is no qualifying for permanent when construction done (i.e. no more paperwork) so if they lose their job the permanent is already in place (though vast majority of folks doing this loan are pretty secure in their employment)
- OTC Disadvantages: rate is subjected to whatever rate the lender wants to give you for your long-term permanent loan. If borrower doesn’t already own the lot (and not buying from builder then seller must wait longtime for closing because building plans, spec, and budget must be ready before appraisal ordered.
Questions to Ask
A Financial Advisers mortgage cheat sheet wouldn’t be complete if we didn’t have some tips to help Advisers conduct the proper due diligence. Gather the correct data in its entirety at your initial meeting with the client is critical. Doing so demonstrates that the Adviser knows what’s required and minimizes followup questions and additional work with teh client. It also will allow both Adviser and Mortgage Lender to explore all options quickly and accurately.
Refinances are interesting because a scenario make not make financial sense from a cost vs. savings standpoint, but can be needs-based and serve a purpose. Example: if someone has a 15 year loan and needs to refinance to a 30 year with a higher rate to lower the monthly cash flow. This brings up the question: when to refi and when not to refi? A common misnomer is that there needs to be a 1% drop in rate. This is simply not true. A .375% drop on a $1MM loan amount produces significant savings.
We conduct a true Refi Analysis and compare the original loan to the proposed new loan and only discuss savings in interest paid. A drop in payment doesn’t always mean there’s a financial benefit, especially if it’s resetting a loan amortization schedule by many year (like 7 years and beyond). Our opinion is that savings should justify the costs within a few short years.
Here’s what the Financial Advisers Cheat Sheet says an Adviser should get from clients:
- Value of home
- Mortgage balance(s)
- Interest rate(s)
- P&I payment(s)
- MI payment (if applicable)
- Date when current loan closed (this impacts title costs)
- Loan type (30 yr, 15 yr, ARM, etc.)
- Desired structure for new loan (i.e. what loan type do they want and what’s the objective)
The easiest way to get most of this information is via a current mortgage statement.
Typically the main focus for purchases from an Advisers perspective are typically how much to finance, what’s the monthly payment, and how much cash will the client need (and where will it come from). We’re believers in mortgages and consider them a “good” debt which means there’s a delicate balance between the amount financed and the monthly payment. Every client has different needs which is why it’s imperative that Advisers and Lenders work together and use this Financial Advisers Mortgage Cheat Sheet.
What an Adviser should when a client is thing about buying a home:
- Price range (what’s the maximum price point)
- How much do they want to finance and why
- Source of down payment and when do they need it
- Ideal payment (if they one)
- How long do they want/need the loan
- Do they plan to pay the mortgage aggressively, if so, how aggressively (i.e. in time or dollars)
- Will a windfall of money happen anytime soon (via sale of home, bonus, inheritance, etc.)
- How long do they plan on living in the house
These are some of the scenarios and/or some of the challenges lenders face with clients that are referred by Advisers. The Financial Advisers Mortgage Cheat Sheet outlines some perspective on what lenders have to consider. And as previously mentioned, we like mortgages and cash is king. For that reason we like mortgages to be amortized for 30 years and for clients to have the mortgage serve as a instrument within a comprehensive financial plan.
Retirees / Asset Based Loans
Asset based loans are used when the income isn’t sufficient enough to qualify for a mortgage. What makes little to no sense is how difficult it is for these types of loans to be financed when a client can pay cash (multiple times) for a home. Many times this type of loan will be made under portfolio product. The “good news” is that if the Adviser and client have an existing distributions plan (or create one), those distributions can often be considered as income. That said, it’s not automatic so call your best mortgage lender with the great Financial Advisers Mortgage Cheat Sheet before you take a course of action.
Death / Loss of Partner
Since this is a Financial Advisers Mortgage Cheat Sheet we’re going to assume a financial plan has been put in place. What we will say is that someone shouldn’t need to do refinance just because their spouse/partner died. If they want to refinance because it makes financial sense then more power to them; however, if the deceased was the breadwinner in the home then it could prove difficult for the survivor to qualify on their own.
Buy House for Family Member
For this topic our recommendation is to fully understand the “why” and motivation for the purchase. Often times someone has made an (incorrection) assumption that they have to co-sign on the loan or buy it out-right without the party. Determine the ideal scenario and then connect with your mortgage planner to see what options exists.
There can be risks for co-signing with someone. For example if a parent offers to co-sign on their child’s home purchase, this financial obligates the parent to the loan, requires them to do all the normal loan paperwork (i.e. pay stub, tax returns, etc), and has that mortgage reported on their credit (or better or for worse). Often times it’s discovered that the child was able to do the financing on their own and the parent jumped to a conclusion.
Another scenario may be for the client to buy a home for an aging parent. In this case it may be prudent for the borrower to keep everything in their name for planning purposes and not have the parent co-sign. In this example the interest rate can still be “primary residence” rate; however, in the aforementioned example where they buy a home for a child, that would be considered an investment property if they child isn’t on the loan with them. The takeaway from this Financial Advisers Mortgage Cheat Sheet is to call your lender before taking actions based on assumptions.
The term “Bridge Loan” can mean different things. Bridge loans by the laymen basically means borrowing funds for a down payment until their current home sells. One option is to do a HELOC but can be difficult if the current home doesn’t ahve enough equity since Texas A6 loans have the 80% LTV cap.
A TRUE bridge loan is where bank extends excessive LTV financing on new home with expectation of repaying after current home sells. In other words, they don’t do anything with the current home. There are very, very few banks that do this. Typically a trust bridge loans has rates and costs comparable to commercial loans.
Commercial loans can serve a purpose when a client is trying to buy investment properties. Technically these don’t fall under the normal mortgage lender category but it’s worth knowing and we want a complete Financial Advisers Mortgage Cheat Sheet. I (Mortgage Mark) have personally have bought many investment properties via commercial financing.
The typical closing costs exist along with a 1% origination charge that’s paid to the bank. The interest rate is typically 1.5% to 2% higher than a “normal” 30 year conventional rate. The terms are traditionally 3/1 or 5/1 ARMs. Balloon payment often exists after 3, 5, or 10 years. Commercial loans can have prepay penalties but qualifying is far less paperwork. The approval process is often done “old-school” via loan committee. The client can put the property in an LLC (which can’t happen with “normal” mortgages after closing because it triggers due on sales clause). And finally, commercial loans allow multiple properties to be financed under one loan and the equity in existing owned home can be the source for a down payment. Pretty cool stuff.
Divorce scenarios can be tricky depending on what’s needed which is why we made it an entire section in the Financial Advisers Mortgage Cheat Sheet. For example, Fannie/Freddie want a minimum of 6 months of alimony/child support payments being received before they’ll consider allowing that income which means someone could be homeless for months after. Truthfully the guidelines call for 12 months of receipt but 6 months can be considered. Moreover, those payments better come in like clockwork otherwise there’s no chance of using that income.
Separations & Rule 11
If someone is in the midst of a divorce a Rule 11 separation agreement can exonerate a borrower from certain liabilities. It should be noted that if the divorce isn’t finalized by the time someone closes on loan AND they don’t have a Rule 11 agreement, the soon-to-be ex-spouse will need to sign title docs. This isn’t a big deal (assuming all parties are willing to play nice) because the divorce decree can award the new home and loan to the proper owner.
The major concern with a soon-to-be ex-spouse would be if they are on the loan. While a divorce decree supersedes the note’s financial obligation, the mortgage will continue to report on the Ex’s credit until the loan is paid in full. This means that years down the road if the note’s owner misses a mortgage payment, that derogatory credit will be reported and negatively impact the Ex’s scores.
An owelty refinance is a “cash out” refinance that allows the home’s equity to be split among the owners. While this is most often used for divorcing or separating couples, we seen instances where sibling or co-inhabitant have used this refinance. It’s basically a “normal” loan with a few nuances from the lenders and title’s perspective.
In conclusion, this financial advisers mortgage cheat sheet is a great reference and educational tool for Adviser. (At least that’s what we think). The primary takeaway should be what information should be gathered from a client so a mortgage professional can assist with the due diligence process. Traditional mortgage lenders should be able assist with most scenarios referenced above, however, local banks are great outlets for portfolio loans, certain construction loans, and second liens. Just remember that banks typically have slightly higher interest rate and shorter loan terms. In short, call your mortgage lender first and then see where to go from there.