Considering making a home purchase but you're confused about the different types of loans? Don't worry, you are not alone! There are many different types of loan programs that may be available to you. Today we are going to look at four of the most common types of loans and discuss the pros and the cons of each.
Let's start the discussion with the Conventional Loan.
The Conventional Loan is the most highly used loan program. This loan process is usually faster than other loan programs due to the fact that the loan is approved by the lender and does not require a review by a government agency.
As a general rule, there are no loan limits on a Conventional Loan unless the loan will be delivered to Fannie Mae or Freddie Mac. Additionally, in some cases, there will be an option to pay your property taxes and home owners insurance directly without the need of an escrow account.
In the past, one of the biggest reasons that many potential buyers were unable to use a Conventional Loan was the 20% down payment requirement. Over the last few years, many lenders offer as little as 3.5% down for a Conventional Loan. The benefit of providing a 20% down payment is the fact that there will not be any private mortgage insurance, which reduces the monthly payment. If you are unable to put the full 20% down, the good news is that once the loan-to-value reaches 80% you can drop the private mortgage insurance.
As a general rule, a credit score of 680 or above is required for a Conventional Loan. While it is possible to obtain the loan with a lower score the associated cost with the lower score may make other loan programs, such as an FHA loan, more attractive.
Now let's discuss the Federal Housing Administration (FHA) Loan.
The FHA Loan is a loan that is insured by the Federal Housing Administration which is part of Housing and Urban Development. The FHA Loan is very popular for first-time home buyers as it allows for a smaller down payment than other loan programs.
The FHA Loan limits are based on location. The 2017 loan limit for Madison and Limestone County Alabama on a single family home is $275,665.
Typically a down payment for a FHA Loan is 3.5% of the purchase price of the home. Because an FHA Loan is an insured loan it requires the purchasers to obtain mortgage insurance. This is a two part mortgage insurance with an upfront premium that can be financed as part of the loan and a monthly payment that will be included in your monthly payment. Unlike a Conventional Loan, mortgage insurance on a FHA Loan will remain throughout the life of the loan. Currently, in Alabama, you can get assistance with your down payment through the Alabama Step Up Program.
If you plan to only put down 3.5% you will need a minimum credit score of 580. It is possible to get a FHA loan with a credit score of less than 580 but the minimum down payment will increase to 10%. Lenders prefer that loan applicants have a credit score of 600 or higher.
A great program for military veterans is the VA Loan.
The VA Loan is a loan guaranteed by the Department of Veterans Affairs (VA). The VA loan has no private mortgage insurance and can be obtained with zero money down.
Similar to the FHA Loan, VA Loan limits are based on locations. For Madison and Limestone County in Alabama, the loan limit is $424,100.
One of the greatest benefits of the VA Loan is the fact that it requires zero money down. That is good news for many that have the ability to make a monthly mortgage payment but struggle with coming up with a down payment. One of the down sides to zero money down is the fact that it will take longer to build up any equity in your home. Also, while there is no private mortgage insurance, there is a funding fee which is a percentage of the purchase price. For a first-time user of a VA Loan with zero money down, the funding fee is 2.15% of the purchase price. If you have the ability to put 5.0 - 9.9% down, the funding fee lowers to 1.50%, and if you can come up with 10% or more to put down, the funding fee is a very low 1.25%.
While this can vary between lenders, a credit score of 620 or above is required to obtain a VA Loan. Interest rates will also vary based on your credit score.
The final loan program that may be available depending on the location of the home is the Rural Development Loan.
The Rural Development (RD) Loan is another zero down program. This loan program is guaranteed by the USDA for homes located in approved locations.
Loan Limit / Income Limit
Rural Development Loans, much like FHA and VA, have loan limits based on locations. In Madison and Limestone County Alabama, the loan limit is $149,900. In addition to, loan limit there is also a maximum income limit to obtain a RD Loan.
Similar to a VA loan, an RD Loan can be obtained with zero money down. While there is no monthly private mortgage insurance there is a one time upfront premium of 2% of the purchase price of the home. The USDA will allow for this upfront fee to be financed into your loan.
As a general rule, a credit score of 640 or higher is required for automated underwriting. It is possible to have a credit score as low as 600 but will require manual underwriting.
Hopefully, this overview has provided some clarity to the different type loans that may be available to you. Please don't hesitate to reach out to me if you have any questions. Please be aware that this is a general overview of different loan programs and that credit scores, loan limits, income limits and other variables of each loan program can change.