Unless you are blessed with a large bank account that allows you to pay cash for your house, you’ll have to borrow some money. There are two basic types of loans you can pick from. The difference between them is how much of a down payment you make.
The down payment is a big factor because, to banks, down payments indicate risk. Large down payments mean a more secure loan because you have more “skin in the game.” To calculate risk, banks use a Loan-to-Value ratio. For example, if you have a $200,000 house with a $180,000 loan, the LTV ratio is 90% ($180,000 / $200,000).
Loans with an LTV of more than 80% require Mortgage Insurance, which insures the lender against you defaulting on the loan. Mortgage insurance is an additional cost to you, but it’s a trade-off for a lower down payment.
Conventional Loans
Back in the day, conventional loans were the gold-standard. The security for the loan is provided solely by the mortgage. House appraisals are very important to the lender, as are the borrower’s credit history and income reliability.
Traditionally, you put 20% down (for an 80% LTV ratio) with conventional loans. Today conventional loans can be obtained for 10%, 5% and even as little as 3.5% down, although very few banks offer programs with low down payments. Also be aware that down payments of less than 20% require some mortgage insurance. Check with your banker for details.
FHA / VA Loans
The terms “FHA and VA loans” refer to loans insured by the Federal Housing Administration (FHA) and Veteran’s Administration (VA). The FHA and VA do not lend money. Loans are made by FHA and VA approved institutions.
The big selling points of FHA and VA loans are that they only require a 3.5% down payment, and they are widely available. With FHA and VA loans you will have to buy mortgage insurance. There is an up-front premium charged at closing, which can be financed. And there is an annual premium, usually charged monthly.
Mortgage insurance is expensive, as much as 1.75% of the loan. There is light at the end of the tunnel. By law, when you accumulate 22% equity in the property (based on the purchase price of the home) you no longer need mortgage insurance.
For a list of lenders that I like to work with, email me at: gary.clark@century21.com
Gary Clark's Real Estate Tips 