In their assessment of the available loan options, many borrowers overlook two mortgage programs that can be worth considering: those mortgages insured by the Federal Housing Administration and those guaranteed by the Veterans Administration.
FHA loans in particular are often ignored today because the below-market interest rate that used to be one of the program`s primary attractions has been eliminated. But these loans can still have some definite advantages, primary among them being a relatively low down payment requirement. The lowest down payment required on non-federally insured loans is 5 percent, but in practice most borrowers today must come up with a minimum of 10 percent down. An FHA loan requires only 3 percent down on the first $25,000 of the purchase price, and 5 percent down on any amount above that. On a $100,000 loan, for example, a conventional borrower would have to come up with at least $10,000 as a down payment, while the FHA borrower would need less than half of that.
Another advantage of both FHA and VA loans is that they are fully
”assumable” by other borrowers. To ”assume” a loan is essentially to step into the shoes of the seller and take over the responsibility for paying off his or her loan. This can be an attractive arrangement if the rate on the seller`s loan is significantly below the prevailing mortgage rates that would otherwise be available to the borrower.
Comparing payments
Take a seller who has an $80,000 FHA loan written at 6 percent, with an outstanding balance of $60,000. The selling price of the house is $100,000. The buyer assumes the $80,000 mortgage, which relieves the seller of the need to pay off the $60,000 balance. To complete the purchase, the buyer will either have to make a $40,000 down payment or finance a loan for the same portion of that amount. Let`s say the buyer has only $20,000 available for a down payment. That would leave $20,000 to finance at the prevailing rate of 11 percent. The monthly payment on the assumed mortgage would then be the sum of $480 (the payment on the original FHA loan) plus $190.60 (the payment on the new $20,000 loan at 11 percent), or a total monthly payment of $670.60. If the buyer didn`t assume the seller`s mortgage, however, and instead put $20,000 down and obtained an $80,000 mortgage at 11 percent, the monthly payment would be $762.40. So, in this case the assumable mortgage could make a significant difference-$91.80 a month-to a buyer on the margin of affordability.
The numbers don`t always work out this way, though. The higher the rate on the mortgage being assumed, the less advantageous it`s going to be. So, if you run into the possibility of assuming a mortgage, be sure to study the numbers carefully to make sure it`ll be worth your while.
If you`re the seller, having a mortgage that can be assumed by another borrower can be a definite advantage if interest rates are much higher than the rate on your mortgage, since that may increase your chances of finding a buyer. (ARMs, by the way, are almost invariably assumable, but fixed-rate mortgages usually aren`t.) There is one caveat here, however. With a VA loan, you want to be sure that the buyer assuming the loan is eligible in his or her own right for VA financing. Otherwise, you`ll continue to be liable for the loan, even though the new borrower has assumed responsibility for making the payments.
You don`t have to meet any membership or income requirements to qualify for an FHA loan, but there`s a limit on the size of the mortgage you can obtain under this program. In markets where home prices are high, these ceilings can make the FHA program unworkable. Currently, the maximum loans allowed in ”high-priced” areas are $101,250 for a single-family home or condominium, $114,000 for a two-family, $138,000 for a three-family and $160,000 for a four-family dwelling.
These are the maximums, however. The ceiling in some markets is as low as $67,500 for a single-family home. For someone putting down the minimum amount, the maximum purchase price, in a high-priced area, would be only about $105,000. That won`t get you very far in areas such as New York and Los Angeles and Boston, where the average price for a single-family is more than $180,000.
VA loans
Loans guaranteed by the Veterans Administration have most of the advantages of FHA loans and then some, but they also have eligibility restrictions. They are available only to veterans of the armed services, those currently in the service and their spouses. VA loans typically are half a percent or more below prevailing market rates, and they can be obtained with no money down. The VA does not actually limit the size of the mortgage a lender can approve, but it does limit the portion of the loan on which repayment is guaranteed to the lender.
This has the effect of limiting the amount lenders are willing to lend under the program. The size of the guaranteed portion has recently been increased, so that on loans of about $45,000 or more, the VA will now guarantee 40 percent of the principal amount, or $36,000, whichever is less. For loans with a principal balance below $45,000, the VA guarantee will cover 50 percent.
What that means as a practical matter is that a VA borrower who doesn`t put any money down will be able to pay up to about $144,000 for a home.
(Lenders typically want the VA guarantee plus the down payment to equal at least 25 percent of the mortgage amount.)
The major drawback to a VA loan is the number of discount percentage points (known simply as ”points”) lenders charge to bridge the gap between the market rate and the VA rate. The borrower is allowed to pay only one of those points, plus a 1 percent financing fee. Any additional points required must be paid by the seller, and not all sellers are delighted to do that. On the other hand, sellers in a slow market who are eager to make a deal will often pay the discount points and (though they are not technically supposed to do so) make up the difference by increasing their asking price. There`s no limit on the price of homes that can be purchased with VA financing, except that it cannot exceed the VA`s appraised value for the property.
One serious disadvantage of both FHA and VA loans is the amount of paperwork involved. It can take considerably longer in some markets to get an FHA or VA loan approved than it does to obtain a non-federally insured mortgage. Government efforts to streamline the procedures have made this less of a problem than it used to be, but you may find some sellers and brokers hesitant to work with buyers who are planning to seek either FHA or VA financing.
That doesn`t mean you should ignore these options, but you should be prepared to overcome some resistance to them.
