You have many choices when it comes to various loan products, as you decide to fund an investment property. All, though, can be put in two broad categories: loans conforming and loans non-conforming.
While compliant loans generally offer lower interest rates than non-compliant loans, they can be rather difficult to obtain, especially for investors. With that in mind, here’s a snapshot of the differences between matching loans versus non-conforming, and how to determine might be the best choice.
What is an equivalent loan?
A matching loan or mortgage is a loan used to purchase immovable property which has two basic characteristics:
- It follows the criteria set by Fannie Mae and Freddie Mac for the underwriting. They are the two government-sponsored companies buying mortgages, but they can only purchase loans that “comply” with their requirements, thus the term “compliant loan.”
- This is equal to or less than the applicable home loan caps, which are determined quarterly by the Federal Housing Finance Agency (FHFA).
Bearing these two traits in mind, let ‘s look at each one more closely.
Complying with loan underwriting standards
Since this article is directed towards real estate owners, let’s take a peek at the latest underwriting requirements on investment property mortgages from Fannie Mae. You will consider them in Fannie Mae ‘s Eligibility Index, if you want to see the lending standards for owner-occupied properties.
Fannie Mae is looking into a few issues before determining eligibility. Standards are based on a combination of the debt-to – income ratio (DTI) of the borrower, the mortgage loan-to – value ratio (LTV), the borrower’s credit score and how many months of expenses the creditor has in inventory.
Here are the current standards for investment property acquisition mortgages if you have a debt-to – income ratio of 36 per cent or less:
|NUMBER OF UNITS||MAXIMUM LTV||CREDIT SCORE REQUIREMENTS||RESERVE REQUIREMENTS|
|1 Unit||85%||680 if LTV >75%640 if LTV ≤ 75%||6 months|
|2-4 Units||75%||660||6 months|
For a DTI above 36 percent but less than or equal to 45 points, the criteria are a touch more strict in terms of the credit score of the borrower:
|NUMBER OF UNITS||MAXIMUM LTV||CREDIT SCORE REQUIREMENTS||RESERVE REQUIREMENTS|
|1 Unit||85%||700 if LTV > 75%680 if LTV ≤ 75%||6 months|
|2-4 Units||75%||680||6 months|
Meets loan goals for 2020
As mentioned, there is a maximum amount of loan allowed to match loans, which changes annually and is set by FHFA.
The conforming lending limits are the same in most parts of the United States. However, in certain high-cost areas the thresholds are higher. Here’s a quick reference map of the 2020 loan caps, but you can find them on Fannie Mae ‘s website if you want to know the exact limits in your area. (Note: some areas have loan limits between standard and cost-effective limits.)
|NUMBER OF HOUSING UNITS||STANDARD LIMIT||HIGH-COST AREA LIMIT|
It’s worth noting that these are the loan caps, not the price requirements for the transaction. In other words , as long as you don’t expect to borrow more than the accompanying limit, you will buy an investment property that meets these caps by a broad margin with a conforming loan.
Loans vs. new loans
Loan-conforming words and traditional loans are often used interchangeably, but that is incorrect. A loan that conforms is one that follows the requirements set out in this section. A traditional loan is one that the Bank does not fund or grant. Fannie Mae and Freddie Mac purchase mortgages but they’re not directly backed by the government. Federal Housing Administration (FHA) mortgages and Veterans Affairs Department (VA) leases, on the other hand, have a federal loan, and are also not traditional leases.
An significant argument is that traditional loans can be both conforming and non-conforming, as long as there is no government guarantee attached.
What is a default loan?
The term non-compliant loan is a broad term that refers to any type of mortgage loan that does not meet the standards outlined in the previous section. That includes but is not necessarily restricted to:
- Jumbo loans: A jumbo loan is one that does not qualify as compliant as it exceeds the FHFA loan limit applicable.
- Poor credit loans: These are investment property lenders who accept applicants with poorer credit ratings than Fannie Mae ‘s requirements.
- Asset-based lending: There has been an uptick in asset-based lending in recent years. Such guarantees are largely dependent on the property’s credentials, not the borrower. Usually, the borrower’s credit score would be reviewed by an asset-based lender but considerations such as personal loans and wages are not included.
- Low-down payment loans: Real home lenders will be provided on homes with two or four units with less than 25 per cent down payment, but they may be non-compliant.
- Loans to businesses: Loans that apply must usually be provided to you as an person. When you want to borrow money from an LLC or other legal company, you would definitely need to seek a non-compliant loan.
What is better: loans that comply or are not in compliance?
When you can apply for a loan that conforms, this is usually the safest way to get there. Source rates tend to be smaller than those paid on non-compliant loans on investment assets. So while the interest rates on investment property loans are almost always higher than you would get on a primary residence mortgage, you should expect a smaller disparity if the investment property loan is in first.
At the other hand, a conforming loan can be difficult to acquire, particularly if you’re in a high-cost market. For example, if you choose to buy a duplex in San Francisco, finding one for less than the $980,325 limit which extends to high-cost areas can be very challenging.
Debt-to-income also poses a significant barrier for many lenders. The overall debt-to – income ratio of 45 percent allowed under Fannie Mae ‘s guidelines covers mortgage payments on the primary residence (and all other real estate), as well as other recurring debt commitments such as vehicle loans, student loans , credit cards and other installment debts. You may be entitled to use any of the projected net revenue from the property for qualified purposes, but it isn’t going to benefit enormously.
At the other side, qualifying for a non-conforming loan can be almost as complicated (if not more so). In simple terms, if your loan fails for one or two reasons, the remainder of your qualifications may need to be even better. For eg, I know of a lender of investment property who will offer 80 percent LTV loans on 2- to 4-unit properties, but only for lenders above 720 with credit scores.
And you can expect to pay a higher interest rate on a non-conforming loan. As a personal example, I got an bid for a similar investment property mortgage with an interest rate of 4,625 percent at a time when 30-year fixed-rate mortgages on owner-occupied properties paid 3.7 per cent APR. Whereas, the best I saw at the same time was 6.25 per cent from an asset-based lender.
If you want to borrow through an LLC, your DTI is over 45%, or you want to buy a property worth $2 million, just to name a few examples, the best (and only) choice is obviously a non-conforming loan. On the other hand, if you can qualify for a matching loan, a lower interest rate, as well as an easier approval process, is likely to come along. The bottom line is that the “what is easier” question has no absolute correct answer. It depends on whether you are in.
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