July 15 2024: Discover the Best Options for Loan Types and Down-payments!
Hello everyone! Today, I’m going to walk you through and break down the most common and widely used loan types available for your home mortgage. We will talk about the pros, cons, and down payments. I’m Joe Nelson of the Nelson Home Group, Kansas City’s highest-rated real estate team on Google. I’m also a licensed mortgage loan originator with Nexa Mortgage. I’m specifically going to be talking about the home loans available for resale homes today.
Today, I’m going to break down conventional loans, FHA loans, VA loans, USDA loans, and stick around until the end because I’m also going to share with you some less traditional loan types with zero down options. By the end, you should have a good starting point to discuss with your lender and your realtor which loan type is right for you. Let’s dive in!
Conventional Loans
The most popular type of home loan that you’re likely most familiar with is the conventional loan. Conventional loans are mortgages not backed by the federal government. Because of this, lenders typically require higher minimum credit scores.
Let me start by saying with all loan types, there is not usually a black-and-white hardline cutoff for minimum credit scores, and I get asked that question all the time. In theory, conventional loans can be done with a credit score as low as 620, but typically for someone whose credit score is in the 600s, most borrowers do not use this loan type unless there are some extenuating circumstances that might require it. The higher the score, the better the rate, usually capping out at about 760 or 780 depending on the lender. With lower credit scores, interest rates will shoot up, and they can also be harder to qualify for than the government-backed mortgages.
Usually, you’ll need to put down at least 20% of the purchase price, or the lender will require you to pay private mortgage insurance or PMI. Now, don’t let that scare you off; PMI is simply insurance on behalf of your lender that you pay, but it covers the bank in the event they have to foreclose on you and you owe more than the house is worth. It’s kind of like gap coverage on a car loan if you’ve ever heard of that. That said, this is where the conventional wisdom of saving up a 20% down payment to buy a home comes from, but it’s not necessary. A lot of conventional loan buyers are not putting 20% down. You no longer have to pay that PMI once you reach 20% in equity, which is nice. With conventional loans, PMI does not stick around for the life of the loan. If you don’t have 20% to put down at closing, that won’t exclude you from a conventional loan at all. You can actually secure a conventional loan with as little as 3% down, however, the most common down payment for this loan type is 5%.
This type of loan is great for someone with solid credit, a steady employment history, and some cash for a down payment.
FHA Loans
The next most popular loan type that you may have heard of is an FHA loan. FHA loans are backed by the Federal Housing Administration, and because it’s backed by the federal government, your credit does not need to be as high to qualify as with a conventional loan. Your minimum down payment could be slightly higher than with a conventional loan depending on credit score. For example, with a 580 credit score, you can expect to pay about 3.5% down. Between 500 and 579, you can expect to pay 10% down.
Remember though, there is no hard line on credit scores, so just because scores are in those ranges and you have that money saved up does not mean that you’ll automatically qualify. There is so much that goes into loan pre-qualification beyond just credit score, and often it can depend on why your credit score is even in those ranges to begin with. Generally speaking, 620 or higher is going to give you the best shot at getting qualified for an FHA loan with 3.5% down, and this can all be gift money as well, which is a nice bonus with FHA loans.
One drawback to an FHA loan is that you’ll have to pay a mandatory FHA mortgage insurance premium for the life of the loan if you put less than 10% down. Even when you put 10% down at closing, you’ll have to pay that premium for 11 years. You can always get rid of this in either scenario if you choose to refinance to a conventional loan after building up that 20% equity. Keep in mind that as a government-backed loan, the requirements to meet the appraised value for underwriting are going to be higher. When making an offer above the listing price, there’s a greater chance the property may not appraise for or be less than contract price, or there could be repair stipulations to meet qualifications for the loan.
An FHA loan is a good option for someone with slightly lower credit who can put a minimum of 3.5% down.
VA Loans
Next, let’s talk about VA loans. VA loans are backed by the United States Department of Veteran Affairs. This kind of loan is available to military service members, veterans, and their spouses. The biggest sell for a VA loan is that it requires no down payment, and there’s no monthly mortgage insurance requirement or income limits. No PMI and competitive interest rates make your monthly affordability very appealing with this type of loan. That means you can buy more house and spend less each month.
However, unless the veteran is at least 10% or more disabled with the VA, there will be a funding fee on the loan in place of PMI. So just because you’re a veteran does not mean this is always the best loan type for your situation. Depending on your service type and if this is your first use of the loan and if you’re opting to put some money down, this fee can range from 1.25% to 3.3%. This is tacked onto the loan amount; it’s not paid upfront as a closing cost usually. So, let’s say you’re buying a $300,000 house with zero down payment. Your loan amount could be as high as $309,900. Assuming the appraised value comes in at $300,000, you’ll be almost $10,000 upside down on the house the day you take possession. Now, if you’re going to stay in the house long enough, that may not matter, but it is definitely something to consider.
The lender must also use a VA-approved appraiser and appraisal process, which does run the risk of extending the time it takes to close on the loan. Like with FHA loans, there is an increased likelihood of stipulations needed for repairs for the appraisal to clear underwriting. While the VA does not set a minimum credit score for this type of loan either, many lenders will require a credit score at least in the low to mid 600s. While there are plenty of qualified military borrowers who choose to use conventional loans, VA loans are a great option for those military borrowers who can’t afford the down payment or just want to avoid PMI.
USDA Loans
Another common loan type we see in more rural areas is the USDA loan. USDA loans are insured by the US Department of Agriculture, and the goal of this loan type is to provide low and moderate-income buyers the funds to buy their primary residence in rural areas. The USDA provides an eligibility map online to verify if an address falls in one of these designated areas. While a USDA loan won’t help you close on an urban loft in the center of downtown Kansas City, many of the surrounding towns on the outskirts of Kansas City are included in the designated rural areas.
USDA loans don’t require a down payment or mortgage insurance, but unlike VA loans, there are limitations on income to qualify. Some USDA loans even limit how large the property can be and what the amenities can be. The home also has to be your primary residence, so vacation homes and investment properties won’t qualify. For someone with lower or modest income, lack of down payment, and looking to move to a rural area, the USDA loan could be a great fit.
Down Payment Assistance Programs (DPA)
Okay, so what if you have no down payment but you want to buy a house and you don’t qualify for any of these mentioned loan types so far? Well, there are often plenty of other options available to you. Thanks for sticking around to this point. We call these down payment assistance programs or DPA. For example, in most states, you can get a state-sponsored down payment program, but be careful because these can sometimes be a little misleading. In Missouri, for example, MHDC is the Missouri Housing and Development Commission, and it offers down payment assistance, competitive interest rates, and tax credits to home buyers in the state of Missouri. They currently offer three different home buyer programs depending on the borrower’s needs and qualifications.
The downside to this program is that while it will give you down payment assistance, if you do not keep the house at least 10 years, you will have to repay some or all of the assistance depending on how long you keep the house. Oftentimes with higher PMI rates, this means it will cost you more in the long run. The best advice I can give you is to make sure that you educate yourself on the pros and cons and know what you’re signing up for.
Outside of state-sponsored DPA programs, many lenders and sometimes local banks also offer various zero-down or down payment assistance options. So, shop around and ask questions. Usually, your realtor will be able to point you in the right direction since they do this so often. They may know of some lesser-known loan options in your local market. For example, in our market, we currently have a down payment program that offers 3% DPA as a silent second mortgage on the home. The 3% DPA is a 0% loan that is paid back only when you sell or refinance the house. Again, I repeat: ask questions, shop around, lean on your realtor, and educate yourself.
If you’d like to learn more about the zero down loan program that we offer, make sure to give me a call. Make sure to come back next Monday for our next blog post, and as always, give us a call or send us a direct message if you’re thinking of making a move in the Kansas City area. Let Nelson Home Group be your Kansas City real estate experts of choice. See you next time!