Posted on by dspaz77

Mortgage Loans

When you buy a home or an investment property the main ingredient is the mortgage loan. The rates and terms could make a great deal bad or a bad deal great. There is quite a bit to learn and understand but is important for you to take the time to understand some of the basics. There is no way we can cover it all in one post but read on to learn a few things about loans.

Following three rate cuts in 2019, the Federal Reserve held its benchmark federal funds rate at a range of 1.5% to 1.75%, according to Paul Davidson of USA TODAY. Fed Chairman Jerome Powell noted in his comments that “Uncertainties about the outlook remain, including those posed by the new coronavirus…There is likely to be some disruption to activity in China and globally…But it’s too early to say what the effect will be.”

As such, rates have hit almost 3-year lows. According to Aly Yale of Forbes, the 30-year fixed loans dropped 7 basis points this week to an average of 3.51%. “It’s the lowest rate seen since September last year—when rates hit 3.49%—and the second-lowest rate since mid-2016.”

Image

Source: Forbes

According to Yale, this rate drop resulted in an 8% increase in refinancing activity, which is now 146% higher than it was this time in 2019.

Natalie Campisi of Bankrate discusses current low rates by historical standards. In 1985, the 30-year rate dropped to 3.5 percent, which is only 20 basis points away from today’s current rate. “A sluggish housing market with low inventory is also doing its part to keep rates low. Last month, pending home sales fell to 4.9 percent, according to the National Association of Realtors, or NAR. All four major regions saw a downturn, with the south getting the hardest hit.

Diana Olick of CNBC discusses some of these options, noting that with the new low rates, “9.4 million borrowers could save an average $272 per month if they were to refinance to a lower rate…That’s a collective $2.6 billion per month, the highest potential savings in 20 years.”

Conforming loans vs. jumbo loans in the mortgage world

The Guidelines

Each year in October, the Federal Housing Finance Agency, or FHFA, collects data on the national median home value and compares that number to October of the previous year. If there is an increase, the conforming loan limit will increase by the same amount.

In October 2019, the year-over-year median home value increase was 5.38%. Therefore, the conforming loan limit for a single-family home in 2020 will rise to $510,400, up from $484,350. The loan limits on multi-unit properties will rise to $653,550, $789,950 and $981,700 for a duplex, triplex and fourplex, respectively.

Loan Differences

Loans amounts at or under these limits qualify as conforming loans. They “conform” to guidelines set forth by Fannie Mae and Freddie Mac. Conforming loans make up the majority of residential loans funded. Loan amounts that are above these limits are referred to as jumbo loans. With a conforming loan, lenders are able to sell the mortgage in the secondary market, replenishing their credit lines in order to make more loans. Jumbo loans have no such robust secondary market. When a lender approves a jumbo loan, it assumes the risk should the loan ever go into default.

Naturally, this makes it more difficult to qualify for a jumbo loan. The minimum credit score for most conforming loans ranges from 580 to 620. Jumbo minimums range from 720 to 740. Some jumbo loans can require a lower score, but the rates and terms are much more stringent.

Down payment requirements for jumbo loans are also much higher. A buyer can secure a conforming loan with a down payment of just 5% (or even 3% for special first-time programs) with the help of private mortgage insurance. Jumbo loans have no such insurance policies available and require a minimum down payment of 20% of the sale price of the home. Providing a down payment of 25% or more will make it easier to qualify.

What does it all mean?

In most instances, unless you are in a very expensive location like parts of CA or HI, you won’t ever have to worry about a Jumbo loan. But you will need a conforming loan and with that there are more break-downs. You have a conventional loan and then there are other types of loans such as FHA and VA. The FHA is, I believe, the most commonly used. It allows home-buyers to purchase a home with a low down payment, 3-5%, and they (the Government) takes the risk from the bank. These are Fannie Mae and Freddie Mac loans.

The bank you use however has the control over what terms and rates they want to charge. Obviously the better your credit score the better rates you will receive. If you have a low credit score you will be perceived as more risky and therefore the bank wants to mitigate that risk by offering you a lower loan amount and higher interest rates.

Right now, late 2019 and going into 2020, we are still at all-time historic lows for mortgage loans. We have been for the last 20 years. Who knows how much longer that will be. For now it is the ‘norm’ but it wasn’t that long ago, in the 70’s and 80’s it was the ‘norm’ to be double digit interest rates. So definitely take advantage and lock yourself in with low rates on as many as you can acquire for personal and rental properties. Lower interest translates to higher cash flows. The lower the interest rate, the lower your payments will be. Bankrate.com is a great site to check out current interest rates.

Besides interest rates another thing banks may do is points. They may charge some up-front points to originate the loan. 1 point is equal to 1% of the loan amount. The higher the points, the more fees they will charge you. Some may not charge any points.

15 vs 30 year loan

You have many options to payment structure. You can even customize them for 10, 18, 25, or whatever number of years you want to pay off your loan. The most commonly offered are 15 and 30 year loans. The longer the loan term the smaller your payments will be, but also the more interest you will pay over the life of the loan. Personally I will always opt for the 30 year loan. The reason for that is that you have the lowest minimum payment to make. You can always pay more and still even pay it off in 5 years or whatever if you want, but at least you are set for the lowest payment that you have to make in case something unexpected happens. If you have an emergency and need to spend your money on medical bills, or you lose your job and have no income for awhile. You hopefully will still be able to make that minimum payment and not be locked into a higher payment. But you can pay extra to your principal and still pay it off in 15 years or sooner. 15 year loans typically come with a lower interest rate as well, usually about a half a percent.

As a side note, some Jumbo loans can go to 50 years.

ARM vs Fixed

An ARM is an Adjustable Rate Mortgage. This means that the interest rates can change. This could be good or bad. In our present market with such low interest rates I consider it a bad idea to use an ARM to purchase a property. Unless you know for sure that no matter what you will sell it in the next couple of years. How ARMs work is you get a very low introductory interest rate for maybe 2-5 years, after which it ‘adjusts’ to the interest rates at that time with maybe an extra 0.5% on top. So if rates go up significantly in the next 5 years, your mortgage payments could double. This is part of the problem that led to the 2008 crash. People were getting ARM loans because they had lower payments and home prices had been going up fast so everyone thought they would sell in a few years anyway and make some money. Well prices dropped, they would sell at a loss, and their mortgage payments went up and they could no longer afford the payments.

This is why I prefer a fixed mortgage. This means that the interest rate will not change throughout the life of the loan. If you get it at 3% now, it will still be 3% 20 years from now. This helps you to be able to budget properly. The only thing that may change your total payment is if your property taxes and insurance rates change, which they often do.

PMI or MIP

Normally when you make a low down payment, the loan becomes risky. That’s when you are required to pay Mortgage Insurance Premium or MIP, which is also called PMI, which are both the same thing. This is like an insurance payment to guarantee the loan in case you default and don’t pay. This is supposed to automatically drop off once your loan remaining is about 28% paid off. Like as if you had put down a large 25% down payment to begin with. But it doesn’t always automatically drop off. You may have to call your loan servicer about it. And in some cases, even if you have not paid off a lot of the loan, but the property has increased in value, you may be able to drop the PMI if the homes value is significantly higher than the remaining loan amount or the original purchase price. Maybe you made some improvements to force appreciation or it is just general market appreciation. Either way it can be removed and may just require an appraisal to be done. This is the case for my primary home. We just have to pay a $150 appraisal fee and if it appraises for the right amount, it can be removed. $150 may seem like a lot if you are cash-strapped. But if you are paying $80 per month in PMI anyway, it pays for itself in 2 months and then it frees up cash for you each month thereafter as well for the life of the loan, even if the values later drop again.

Where to get the right loan?

Before you can even make an offer on a home or rental property, unless you are buying with all cash, you will need to get a pre-approval letter from your bank showing that you are approved for a loan in that amount. If you don’t know where to go, start with the bank you already have an account with. But don’t stop there. You need to shop around. Just because you feel loyal to your bank, they may not be as loyal to you and may not provide you with the best rates possible. Each bank has their own regulations and things they can and cannot do. Small, local community banks and credit unions usually have the most flexibility to be able to work with you. I prefer them for investment loans since they want your business they can offer products the big banks can’t. Such as investment loans with 10% down and no PMI with low interest rates. And portfolio loans which means they keep the loan within their bank and don’t sell it to a third party. Each person is only allowed up to 10 government loans. But if you use portfolio loans or commercial loans, they do not count toward your 10 government loans. The government loans will usually provide the lowest interest because they are guaranteed by the government so they are less risky. But that can limit how many investment loans you can have. So portfolio loans are a great option.

It can be a hassle but you need to call around and talk to the banks and credit unions and even mortgage brokers. Not doing so can cost you thousands or even hundreds of thousands over the life of the loan. It is worth your time to make some phone calls to get the best rates possible for you.

Recently Money.com created a list of some of the best mortgage lenders of 2020. Here is the quick list to save you time to not read the whole article:

The Best Mortgage Lenders for 2020 (according to Money.com)

If interested, here is a link to their full article: https://money.com/best-mortgage-lenders/

I recently learned that Sofi.com now does mortgage loans as well. Sofi has long been a great resource for personal loans, but I did not know that they also now do mortgages. I will be researching that one more to find out what they offer.

Quicken loans is also a great resource for personal and investment property loans. But still, definitely talk with your local community banks. For those in Western States, you should contact Mountain America Credit Union, MACU.com, they have excellent products for investment loans and primary mortgages as well. We even recently used them for my daughters car loan because they also offer additional insurance to replace the car if it is totaled, on top of what our hazard insurance covers. Since it was her first car I thought it was a good idea. I think it was an extra $500 for that coverage.

So check around and then compare the differences and make the wisest decision for you and your future self. Set yourself up for Financial Independence, not Financial Struggles by buying a more expensive home than you need or by getting a loan that costs you more than you could be paying each month. And if you plan to do a house-hack, not all bank lenders understand real estate investing so you may want to find one that does to know how to best suit your needs and qualify you for the right loan.

Disclaimer, the topics mentioned are current as of February 2020, and could change at any time. Please speak with your bank about current rates and loan options. There is too much detail and different loan options available to discuss in one post. Please speak with loan officers at different financial institutions about your options catered to you and your income level and credit score.