Expanded Choices: Mortgage Options Roundup

Buyers look to you to get them started on the road to the best loan. Here are a few signposts.

April 1, 2002

Given the range of mortgage financing out there, deciding which loan option is right for your customers takes more than knowing the difference between a fixed rate and an adjustable one.

Today’s winding financial road passes by hybrids of fixed and adjustable rates, combination mortgages with first and second trusts, reduced or eliminated downpayments, and products with customized underwriting. In this increasingly complex environment, knowing the signposts to the best mortgage option is crucial.

“Your customers need to shop for money as much as they shop for a home,” says Jim Liptak, chair of NAR’s conventional finance and lending committee and a broker with County Real Estate in Paso Robles, Calif. “Every buyer should visit two or three lenders and compare prices and quotes.”

But narrowing the field to two or three is easier said than done. With mortgage companies such as Countrywide Home Loans offering more than 80 home mortgage products, practitioners may feel overwhelmed.

Don’t be; with a few basics you'll know enough to remain a resource for your customers. Form relationships with a few trusted lenders that can help you fill in the details.

30-year fixed offers certainty.

Despite the explosion of loan options, the traditional 30-year, fixed-rate mortgage remains king of the homebuying hill. Eighty-five percent of borrowers still choose these loans.

“Interest rates remain at historically low levels, making fixed-rate loans more affordable. And economic uncertainty makes people want to lock in a payment for the life of the loan,” says Brad Blackwell, national sales manager for Wells Fargo Home Mortgage.

“Families generally prefer knowing what their payments will be in the long term,” says Frank Nothaft, deputy chief economist for Freddie Mac.

Periodically, lenders talk about offering an even longer-term loan, generally 40 years, but the loans have never caught on. “The monthly payment reduction from stretching out your loan over an additional 10 years is not that significant, but the additional interest payments over the course of the loan are,” says Doug Perry, first vice president of Countrywide Home Loans.

15-year builds equity faster.

If anything, the trend is toward a shorter-term fixed-rate period. The higher monthly costs of these loans tend to limit their attraction, but borrowers who can afford them can save on the total interest they pay and build equity in a shorter time period.

“Fifteen-year loans are attractive to people in their mid-40s or 50s who want to know their home will be paid off at their retirement,” says Nothaft. “Generally the 15-year loans run about a half percentage point lower than the 30 year loans, but the monthly payment is higher,” says Nothaft.

Borrowers who like the idea of paying off their loans sooner, but want more flexibility in the size of their payments can choose a 30-year loan and simply make two payments a month. If borrowers fall on hard times, they can just make the regular payment until their financial situation changes. Borrowers who go this route must be sure there’s no prepayment penalty included in the loan terms.

Hybrids lower initial payments.

As home prices continue to rise, loans that help buyers afford higher prices are much in demand. One of the hottest new products addressing this trend is the fixed-adjustable, or hybrid, mortgage. These loans, often called “7-1” or “5-1” loans, have a fixed rate for five or seven years, and then adjust yearly after that.

“There’s a growing interest in intermediate adjustable rate loans among jumbo loan borrowers,” says Blackwell. Jumbo loans, which exceed the Fannie Mae and Freddie Mac borrowing limit (currently $300,700), often have higher interest rates than loans conforming to the Fannie Mae and Freddie Mac standards.

“If the interest rate on a conforming loan is 7 percent, a jumbo loan rate might be 7.5 percent. An hybrid ARM with a 5-year fixed period might be at 6.75 percent. Although on a small loan this might not matter so much, on a $500,000 loan the monthly payment drops from $3,496 at 7.5 percent to $3,243 at 6.75 percent, a savings of $253 per month. That extra money allows buyers to purchase a larger house or to invest the extra money elsewhere,” says Blackwell.

Second loan saves insurance.

Borrowers who couldn’t afford a 20 percent downpayment once had to purchase private mortgage insurance to qualify for a conventional mortgage loan. But now savvy buyers can save that cost thanks to a variety of new mortgage options.

Wells Fargo is one of many lenders that offers an 80-10-10 or 85-15-5 loan product. With these loans, borrowers take out a first mortgage of 80 percent to 85 percent and a second mortgage of 10 percent to 15 percent. They then make a 5 percent or 10 percent downpayment.

This same system can be used for buyers who need to borrow more than the Fannie Mae loan limit, but want the lower interest rate of a conforming loan, says Blackwell. A buyer of a $400,000 home could make a 10 percent downpayment and take out a $300,000 conforming loan and a $60,000 second mortgage at a higher rate.

One of Countrywide’s more popular loan programs, according to Perry, allows buyers to avoid both a downpayment and PMI.

“We allow borrowers of up to $500,000 to take out a first loan of 80 percent and second loan of 20 percent,” says Perry. “Although traditionally no-downpayment loans were reserved for people with perfect credit, this loan has expanded underwriting requirements that make the loans available to people with average to above-average credit.”

Borrowers with excellent credit can also qualify for Countrywide’s “Zero-down-plus Loan,” which allows buyers to finance their entire purchase as well as up to 3 percent of closing costs. The maximum loan amount for this particular loan is $375,000.

Government loans fill gap.

For those who have trouble qualifying for good rates in the conventional market, government-backed loans, principally through FHA or VA, are a good option. Thanks to the government backing of the loans, approved lenders can make loans to applicants who otherwise would have trouble getting conventional financing at reasonable rates.

“VA loans are popular among first-time buyers who qualify because they usually require no downpayment; sometimes buyers can even get closing cost assistance,” says Jan Barnes, a practitioner with Century 21 New Millennium in Lexington Park, Md. “FHA lenders can also be more lenient for buyers with less-than-good credit.”

Both FHA and VA programs set limits on loan size, which varies from county to county in accordance with the local real estate market. Current limits, which were just increased in 2001, are quite generous, though. FHA allows loans up to $262,000 in high-cost areas and up to $144,000 in other areas. VA allows loans up to $240,000.

Although the primary focus of the FHA is to serve low- and moderate-income borrowers, there are no income limits for applying for an FHA loan.

Borrowers of VA loans must have served in the military. In general, veterans must have accrued between 90 and 180 days of active service, although program provisions vary.

Options overcome poor credit.

The bulk of loan alternatives available today are for borrowers with good or excellent credit histories. But what about buyers who have bad credit or who have yet to establish a credit history?

Many immigrant households come to this country with no credit history because they’ve not owned a car or a home or because they’ve paid cash for these items. As a result, they may be almost automatically rejected for a mortgage. To identify households able to meet the financial obligations of buying a home, lenders have had to devise ways outside of traditional credit reporting.

“The lack of credit history is considerably different than having adverse credit,” says Perry. “Most lenders will try to set up an alternative program that can document things like rent payments or utility bills that can demonstrate borrowers have a history of paying their obligations.”

These alternative programs translate into a variety of loan products, including some that allow applicants to use nontraditional payment histories to show they are capable of paying back a loan.

“We can accept up to $600 per month of unverified stated income for people who earn their money from daycare or other types of work usually paid in cash,” says Blackwell. “Potential homebuyers can get into a house with little or no savings in the bank.”

Buyers with impaired credit histories may have a more difficult time than those with no history at all, but programs are available to help them either repair their credit or qualify for a sub-prime loan.

“There are a wide variety of specialized programs that can allow credit-impaired buyers to qualify for a loan,” says Perry. “Countrywide has an entire division, called Full Spectrum Lending, which offers specialized products based on specific situations.”

The specialized products include loans with low monthly payments, fast approvals, flexible verifications, and low application fees.

Credit-impaired borrowers will probably have to pay a higher interest rate—perhaps two or three percentage points over conventional rates, says Blackwell. Loan applicants should be on the lookout for higher, predatory rates that exceed that amount, however. Sub-prime borrowers should also look for loans that let them refinance without penalty at a better rate once they’ve re-established their credit.

Wells Fargo offers the “Homebuyers Club,” which helps credit-impaired borrowers repair their credit and received homebuyer counseling. The goal is to help borrowers qualify for a loan in a year or two. For more on repairing your credit, watch for “Knowing the Credit Score,” in the May edition of RealtorMag Online.

Niche loans benefit “greens.”

Environmentally-conscious buyers who like the idea of living close to public transportation or who want to buy or retrofit a house with energy-efficiency features can choose from a new generation of specialty loans just for them.

The “Energy Efficient Mortgage,” available from Countrywide and other lenders, is designed for buyers of homes that meet a high energy-efficiency standard set by the U.S. Environmental Protection Agency.

“Energy-efficient mortgages usually are offered at a standard interest rate but are valuable because they have easier underwriting and allow buyers to buy a more expensive home,” says Perry. In part this is because the anticipated lower utility bills are factored into the costs of homeownership.

Another new, “green” loan product is the “Location Efficient Mortgage,” which will be offered in a pilot program by Countrywide and other lenders to buyers of homes near public transportation in Los Angeles, the San Francisco Bay Area, and Seattle. These loans, which will be purchased by Fannie Mae, allow lenders to stretch credit ratios, enabling borrowers to buy more house than they otherwise could. The loans factor in the homeowners’ reduced transportation costs to increase their overall income.

Having all these loan options now may require you to do a little more homework so you can best guide your clients. But staying up-to-date also keeps buyers in the fast lane to your door--looking for the perfect home–and the perfect loan.

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