Defining Mortgage Types

Jill asks Dave to explain the different kinds of mortgages and what he recommends.

QUESTION: Jill on Twitter asks Dave to explain the different kinds of mortgages and what he recommends.

ANSWER: There are three types of what we call conforming mortgages. Conforming mortgages are mortgages that conform to standard underwriting guidelines—standard approval processes. They’re then packaged together and sold on the secondary market as a security, as a bond, almost like a very large stock, in other words. They’re securitized. The three types are FHA, which are run by the Department of Housing and Urban Development—HUD mortgages, VA, the Veterans Administration, and Fannie Mae, or conventional lenders. Some of those are also Freddie Macs. Fannie Mae stands for the Federal National Mortgage Association, which is technically not a government program and yet these days really is.

HUD guarantees the lender they’re not going to lose money in the event of foreclosure. You pay an extra fee called mortgage insurance premium (MIP) when you take out an FHA loan. FHA loans are slightly more expensive interest rate-wise. They accept less of a down payment. You can put down a smaller down payment with an FHA, but you’re going to pay a little bit more interest, plus you’re going to pay the MIP every time. There’s no getting out of it.

VA guarantees the mortgage to the lender in the event of foreclosure. If you get foreclosed on and you’re a veteran and had a VA loan, the VA pays Citibank the money back and then they come after you. VA loans are the most expensive of the three. The theory was that the Veterans Administration is established to take care of veterans and to be a benefit to veterans. However, over the years of adding layers of bureaucracy to this mess, it’s ended up that the VA loan is the most expensive of the three. You can get a VA loan literally still today with nothing down, which, by definition, is stupid so you wouldn’t want to do that. We don’t recommend that. We don’t recommend VA loans, not because we’re mad at veterans—we tell veterans we love veterans, we love military folks—but the best thing you can do is to not use a VA loan. They’re more expensive. FHA is the next most expensive.

Fannie Mae, of the three, is the cheapest—the best interest rates and the lowest closing costs, not by much, but by a little and enough that you do want to do it. With Fannie Mae, if you don’t put down 20%, you are required to purchase private mortgage insurance (PMI)—GE or GMAC or somebody like that are some of the sellers of PMI. That will cost you about $75 per month per $100,000 borrowed. So if you borrow $300,000, you’re talking about $225 a month, give or take, just in PMI. It’s pretty expensive stuff if you don’t put at least a 20% down payment. A good 15-year fixed rate Fannie Mae loan would be the only kind of loan I would recommend.

Then there are other loans of all kinds running around out there. They’re not what we call conforming loans. Some of them are for people with bad credit, and they charge a higher interest rate. They are not prime mortgages. They are what we call subprime mortgages. They just caused, among other things, this latest financial debacle we’ve been going through together. Isn’t it fun?

That’s a good rundown for you. You can get more stuff like that if you go through Financial Peace University. We outline all of the mortgage types and how to buy a home properly and all of that. It’s the course we teach you on how to make things happen in your world.

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