Home loans can be generally placed into one of four categories; Conventional, Alt-A and Sub Prime and second mortgages/home equity lines of credit. We will briefly touch on what impacts rates for each of these types of loans.
Let’s start with the most common, conventional loans. Fannie Mae and Freddie Mac are quasi governmental agencies that set the guidelines for what is considered a conventional loan. If a loan meets Fannie or Freddie guidelines, then it is a salable loan that most national lenders lend the money on. Some lenders have their own more restrictive guidelines for different criteria, such as credit scores, but for now let’s keep the discussion simple. Each agency has their own proprietary automated approval system. Once we have your application and pull your credit, the loan is uploaded to this system and it renders an instant approval. If you are approved, you are eligible for the very best interest rates available in the market.
- Alt –A loans are those that don’t quite meet Fannie Mae or Freddie Mac guidelines. For example, maybe your debt to income ratio is just slightly higher than what is allowable. These rates will always be higher but not that much higher.
- Sub Prime loans are generally those for the credit challenged borrower. Generally these borrowers have credit scores that are lower than what would qualify them for an Alt – A loan. We like to think of them as credit repair loans. You get in for a 1 -2 year period, fix up your credit with our guidance and then you refinance into a lower rate, conventional loan.
- Second mortgages or home equity lines of credit are done either to avoid paying PMI (see will I have to pay PMI) or to take out cash later on from the equity that has accumulated in your home. Rates from these loans are always higher because they are in 2nd lien position. This means if the first mortgage lender ever had to foreclose on your loan, the second mortgage lender would likely not recapture the money they lent you. These rates are totally driven by a combination of your credit score and how much you are borrowing against the equity in your home (loan to value ratio).
At this point there are still a few additional items that can either add to the cost of the loan and/or increase your interest rate:
- If you are refinancing and taking cash out, or combining two Loans.
- The structure of the loan. If you are putting down less than 10% for a down payment, there will be additional cost, or a slightly higher rate will be charged.
- Credit scores can also negatively impact your rate. Even if you have an approval, most lenders will charge a slightly higher rate if your scores drop below certain thresholds.
- Paying your own taxes and insurance. If you are putting down at least 20% for a down payment, you are entitled to pay the taxes and homeowners insurance on your own. The bad news is that the lenders will charge a one time .25% discount point fee for the privilege! I guess they figure that if they can’t earn interest on the money they would have been holding for you in escrow, that they will get it upfront.
- Interest rate lock period. The longer a period of time you need to lock your interest rate for the higher the rate will be and/or the more upfront money the lender will require for the commitment they are offering. The standard period of time that most mortgages companies will quote a rate lock for is 30 days. But for example, what happens if you just bought a house that you aren’t closing on until 90 days from now? The difference between a 30 and 90 day lock commitment will probably be around a ¼% higher interest rate. In addition, most lenders will charge some type of up front commitment fee for any rate lock longer than 60 days. So, you can either roll the dice and “float” the rate hoping that time is on your side or lock the loan for the long term protection. Family Mortgage has some lenders that allow you to “have your cake and eat it to”. You can lock the rate now and they offer a “Free Float Down” option. When you get within 30 days of closing, if the rates are better (how much better is defined by the individual lenders but generally they must be ¼% better) you can relock at the lower rate for free. Ask us about this special offer if you have a longer term lock need!
- Rate lock extension fees. If your closing does not take place before the end of the rate lock period, the lender will require some type of extension fee. Each lender has different policies, so it is important to know up front if you think this might be an issue. Where it is most prevalent is in new home construction. If you are building a new home, be sure to give yourself a nice cushion.
- Stated income or no documentation loans. Because these are higher risk loans, it goes without saying that the rates for these will be higher than a loan that you can provide documentation for. How much higher will be determined by a combination of how much of a down payment you are making and your credit score.