Lenders are wooing wary homeowners
In recent years, housing inventory in some areas has been tight, partly because a sizable number of owners who were ready to move up to a larger home or downsize to a smaller one opted to stay put.
Some were underwater - owing more on their homes than they were worth - while others were waiting for the market to rebound so they could get top dollar for their properties.
Now, rising home values are drawing homeowners back into the market, but many remain hesitant. They worry about not being able to find another home in their price range - especially if buying a new one is contingent on selling the one they have.
Lenders are introducing products aimed at getting would-be sellers and buyers off the sidelines and into the game. Among them are adjustable-rate mortgages (ARMs) that reset after 15 years instead of annually and bridge loans for people who need to buy a new home before selling the old one.
ARMs "work well for move-up buyers who want to keep their payments low and who plan to pay down their balance once they have the equity in hand from the sale of their previous home," says Gregg Busch, vice president of First Savings Mortgage Corp. in McLean, Va.
To woo prospective customers, lenders are also backing off some of the stringent requirements introduced in recent years.
Some are loosening slightly their credit-profile standards, and, more important, they have been easing down-payment requirements, says Steve Cohen, senior mortgage banker at Talmer Bank and Trust in Rockville, Md.
"For a little while, you had to make a down payment of 20 percent or do FHA [Federal Housing Administration] financing, but now conventional loans are available with down payments of as little as 5 and 10 percent," Cohen says.
Bill Hampel, chief economist at the Credit Union National Association in Madison, Wis., says: "People typically underestimate the likelihood of getting a loan. There's no question that it's harder today to get a loan than it was 12 years ago, but it's a little bit easier than it was three years ago."
Here are some loan options for people looking to sell their homes and purchase another one:
Adjustable-rate mortgages
While 30-year fix-rate home loans are typically the most popular because of the consistent payment schedule, lenders are offering a variety of hybrid ARMs that could be financially beneficial.
"Most buyers are sticking to the 30-year fixed-rate loans, but if your lender is doing a good job, you'll be asked about your time frame to see whether an ARM that's fixed for five, seven or 10 years is a better fit for your plans," says Dominic Turano, branch manager of First Home Mortgage in Washington.
Hybrid ARMs have been available for years, but some new ones have been introduced recently. For example, Busch says, some lenders are offering 15/15 ARMs that reset only once after 15 years at a fixed rate. The balance is paid off over 30 years, which keeps payments lower than a 15-year loan.
A borrower can lock in a rate of 3.25 percent for 15 years, at which point the rate can go up by as much as 6 percentage points, Busch says. "But even if rates go up, after 15 years you may have moved or paid off your loan because there's no prepayment penalty," he says. "You can also recast these loans, which means that you generate a new payment schedule based on your current loan balance while keeping your interest rate."
Busch says 5/5 ARMs are popular with first-time buyers as well as repeat buyers because the rate stays the same for five years at a time. The interest rate can go up by no more than 2 percent at each resetting and is capped at a maximum of 5 percent above the initial rate. For example, a 5/5 ARM at 3.25 percent could be reset after five years at a maximum of 5.25 percent; the rate could go no higher than 8.25 percent over the life of the loan.
"People like these ARMs when they know they will sell in a few years or they're payment-conscious now but anticipate being able to handle higher payments in the future," Busch says.
Busch says most people keep their mortgage for five to seven years before refinancing or moving, so he says 30-year loans are not really necessary for most borrowers.
Financing for a competitive market
When move-up buyers are in competition to purchase a home, they sometimes opt to buy first and sell their current home later. Cohen says move-up buyers need to be fully approved for a new loan and have their finances organized to compete with buyers who do not have a home to sell.
"Move-up buyers have a few options, including getting a home equity line of credit established before they put their home on the market so they can access that money," Busch says. "They can look for bridge loans that are cross-collateralized between both properties, because more lenders are offering them. Another option is to look for a loan that they can recast into lower payments as soon as they have the profits from the sale of their first home that can be applied to the new mortgage."
Turano says his company recently reintroduced a bridge loan product that it plans to keep in its portfolio - as opposed to reselling it - to help move-up buyers tap into their home equity if they choose to buy a new home before selling the old one.
"If the total loan amount for both homes equal less than $417,000, they need at least 20 percent equity in their current home; if it's more than $417,000, they need at least 30 percent to qualify," Turano says.
Busch says a bridge loan requires that the borrower have a debt-to-income ratio of no more than 43 percent (that is, all monthly minimum debt payments can't exceed 43 percent of gross monthly income). But bridge loans are typically interest-only loans because of their short duration.
"Don't assume you can't qualify," Turano says. "It doesn't cost you anything to talk to a lender about your options. If you don't ask questions, you'll never know the answers."
FHA or conventional financing
Loans insured by the FHA are available to all prospective borrowers, not just first-time buyers. The insurance makes it easier for a lender to provide a mortgage to a consumer with a lower credit score or a higher debt-to-income ratio. In addition, the borrower can make a down payment of as little as 3.5 percent with an FHA loan.
"If your mortgage lender is doing a good job, you'll get an evaluation of FHA and conventional loans to compare and contrast the features in terms of your credit, your down payment and mortgage insurance premiums," Turano says.
FHA loans of up to $625,500 are available in this region with a down payment of 3.5 percent, which Cohen says works well for the many young high earners who have yet to accumulate cash for a bigger down payment. He noted that the requirements are less restrictive than those set by mortgage finance giants Fannie Mae and Freddie Mac for the loans they buy and package for resale to investors.
"Fannie Mae and Freddie Mac have conventional financing programs up to $417,000 with a down payment of 5 percent," Cohen says.
Turano said that for high-cost areas, Freddie Mac and Fannie Mae will buy "high-balance conforming" loans, also known as a "super conforming" mortgages, with balances between $417,000 and $625,500 and a down payment as low as 10 percent.
Mortgage insurance options
If you make a down payment of less than 20 percent, you'll have to buy mortgage insurance.
"FHA recently lowered their mortgage insurance premiums, but the downside is that you need to pay those premiums for the entire loan," Busch says.
Private mortgage insurance (PMI) on conventional loans is eliminated after the loan-to-value ratio reaches 80 percent by virtue of the loan's being paid down or the property's appreciation. Many lenders offer the option of "lender-paid" PMI to borrowers if they have excellent credit.
"Lender-paid PMI feels like no PMI to borrowers because the lender pays the premiums upfront and the borrower pays a slightly higher interest rate," Cohen says. "Even with the higher rate, your payments will be lower than they would be with PMI. Plus, your interest is all tax-deductible."
Another option for borrowers is to avoid PMI with a "piggyback" second loan of 10 percent of the home value on top of a first loan for 80 percent and a 10 percent down payment.
"We'll also do 80-15-5 loans on a case-by-case basis, but the borrowers have to have a strong credit profile," Busch says. "The interest rates on those second loans are a little higher, up to nearly 6 percent, but these loans are a good option for someone who knows they can pay off the second loan quickly."
Turano says borrowers need a credit score of at least 700 or higher, out of 850, six months of mortgage payments - including principal, interest, taxes and homeowner's insurance - in cash reserves and a maximum debt-to-income ratio of 43 percent to qualify for a piggyback loan.
Credit qualifications
Your credit score is a big factor in determining which loan program works best for you.
"If you have a credit score below 700, then an FHA loan is more likely to make sense because FHA loan guidelines don't require a higher interest rate based on your score," Busch says. Also, he says, FHA mortgage rates tend to be about one-quarter percentage point lower than conventional rates.
FHA loans can be approved on a case-by-case basis for borrowers with a credit score as low as 580 without any interest-rate penalty.
Conventional loan guidelines require an add-on to the interest rate for borrowers with a credit score below 740. Busch says conventional loans can be approved for borrowers with a credit score as low as 620, but the increase in the interest rate would be significant. In addition, he says, you would need to make a down payment of 20 percent because PMI companies require a higher credit score to qualify for mortgage insurance.
Depending on the borrower's credit score, Busch says, the interest rate on a conventional loan could be higher by one-quarter percentage point or more.
Portfolio loans offer flexibility
The rules set by Fannie Mae and Freddie Mac for the conventional loans they buy and package for the secondary market are a major cause of strict mortgage requirements, Hampel says.
"If a lender plans to sell their loan to Freddie Mac or Fannie Mae, then they have to meet their requirements, which are pretty uniform across all lenders," Hampel says. "If a loan goes bad at some point after it's been sold, then Freddie Mac and Fannie Mae can go back to the original documentation to look for a mistake. If any mistake has been made, the lender can be forced to buy back the loan."
Hampel says that rule induces lenders to be more stringent in their underwriting practices.
"The exception is that some lenders hold some or all of their loans in their own portfolio and don't sell them to investors," Hampel says. "In that case, the lenders have greater flexibility in making decisions about a loan approval because they are only answering to themselves. They're still careful, but they may be able to bend one rule if it can be balanced with a compensating factor."
For example, Hampel says, a loan might be approved for someone with a debt-to-income ratio that is a little high, such as 45 percent, if the borrower has a high credit score and is making a relatively large down payment of 20 or 30 percent. Borrowers with a low credit score would need a low debt-to-income ratio and a 20 percent down payment for approval.
"This doesn't mean you can go to a credit union or a portfolio lender and always be approved, but your chances are higher there if you have an issue that could make qualifying difficult," Hampel says.