Home Loan Financing Basics- First in a Series

There are two basic types of home mortgages. With a fixed rate mortgage (FRM), your monthly payments will be steady. In contrast, with an adjustable rate mortgage (ARM) , your payments will vary over time. Adjustable rate mortgages typically have an initial fixed rate lower than the rate of a comparable fixed rate mortgage. The initial fixed rate period is followed by adjustment intervals. For example, a “3/1 ARM” is fixed at an initial low rate for the first 3 years, and then adjusts every year based on an index. Common ARMs are: 1/1, 3/1, 5/1, 7/1, and 10/1.

Conforming Loans, FHA insured loans, and Non-Conforming Loans:

Loans are generally categorized by either being “conforming” loans, or “jumbo” loans. Conforming loans are those loans that conform to the requirements of such secondary loan agencies as Fannie Mae (Federal National Mortgage Association) or Freddie Mac (Federal Home Loan Mortgage Corporation ) . These Federal Agencies buy these loans from loan originators. These organizations were originally chartered by Congress to facilitate selling mortgages in “pools” of funds to secondary investors, and reinvesting the proceeds in new mortgages. Both of these organizations had been privately owned by shareholders and chartered by Congress, however are now owned by the Federal Government due to large losses incurred in the housing downturn in 2008. Since the cost of funds for Fannie Mae and Freddie Mac are lower than other lending sources, the interest rate of conforming loans are significantly lower than loans exceeding the conforming loan limits.

Conforming loans generally require a minimum down payment of at least 20%. The Federal Housing Administration (FHA) provides a program of insuring qualifying loans that may have a down payment of as low as 3%. These loans are not purchased by the government, but are simply insured for loss by the Federal government, therefore the interest rates on these loans are among the lowest available. Loans that are FHA insured requires Private Mortgage Insurance if the downpayment is less than 20%. There is an up front mortgage insurance premium equal to 1.5% of the loan amount that is paid at settlement. In most cases, this mortgage insurance premium is included in your loan amount, so you are really paying it over the life of the loan. In addition, on loans with a term of greater than 15 years and a loan-to-value ratio of 90% or greater (meaning you are borrowing more than 90% of the value of the home), you will pay an annual mortgage insurance premium of 0.5% of the loan amount in monthly installments. FHA insured loans are also generally easier to qualify for than conventional mortgages.

The current loan limit for a conforming loan and an FHA insured loan is $417,000 effective 1/1/06 (previously $359,650). Legislation was passed temporarily creating a new loan category called “Jumbo conforming loans” between $417,000 and $729,750 ( for defined high cost areas including California) through the end of 2008, and then reduced temporarily to $625,500 in January 2009, and then raised again to the current $729,750 ( for defined high cost areas ) through the end of 2009. The interest rate spread between conforming loans and Jumbo 30 year fixed rate loans has narrowed during the last quarter but still are approx. .75 % to 1.25 % higher than 30 year fixed rate conforming loans. Jumbo loans also require a much higher down payment of 25 to 30%. This large spread between jumbo loans and conforming loans is amazing considering that prior to the mortgage loan melt down, spreads between conforming and jumbo loans were only approx. two-tenths of a percentage point.