Types of Mortgages: pros and cons of Subprime &

Jumbo mortgages

Getting a mortgage for the first time or indeed getting a new mortgage can be so confusing with technical terms and interest rates that if you don’t understand, could end your dream property being your worst nightmare. We are here to help you navigate your options when it comes to buying a property.

Subprime mortgages are loans accepted to people with lower than average credit scores. Borrowers with a credit score of under 600 who are not approved for conventional mortgages often fall into this category of mortgage. As cruel as it sounds, these loans generally have much higher interest rates than standard mortgage agreements making payments that much more difficult for the borrower.

Like most mortgages there are fixed and variable rate subprime mortgages available. ARM is the most common and the most confusing to mislead borrowers. If you have ever seen the movie “The Big Short” you know all about these. Subprime loans were being issued to borrowers who could make the initial low fixed rates of a subprime while not being able to afford the the much higher jump in higher interest rates, this was one of the key factors in the last recession.

While a subprime loan does carry stigma with its name and concept, this loan may actually be the best option for people with a poor credit score. Here are the pros and cons;

Pros

  • Potential homeowners with a low credit score can save years in waiting for their credit score to increase before buying a property.
  • Providing payments are not missed, Subprime loans can actually work towards improving your credit score while paying off your mortgage.

Cons

  • As mentioned above, interest rates, closing costs and fees all tend to be higher with subprime loans.
  • A higher deposit is usually taken as the lender tries to reduce it’s liability by getting as much money from the borrower upfront in case of defaulting on payments.
  • While credit scores are not a defining factor in qualifying for a subprime loan, your income will be. Lenders must show that they have enough income to financially cover the costs of the mortgage along with all other monthly costs the borrower already has. 

Jumbo mortgages is a loan that doesn’t fit in the loan limits set by the Federal Housing Finance Agency (FHFA) for mortgages to be acquired by Fannie Mae or Freddie Mac. These limits have been stagnant for the past decade however in 2017 they increased from $417,000 to $424,100 with a limit of $636,150.

If your loan amount on a property exceeds these limits, you will probably need to be looking at a jumbo mortgage. While interest rates tend to be around the same average as normal mortgages (4-4.375%), as they aren’t purchased by Fannie Mae or Freddie Mac, they represent a greater risk to lenders. To protect their liability, the approval requirements tend to be much stricter. Jumbo mortgages do vary by lender, but in general, here’s what to expect;

  • You must have a strong credit history with a credit score above 700.
  • Approval can be obtained with a debt to income ratio as high as 45%, however these loans tend to have higher reserve requirements than conventional loans.
  • With a typical mortgage you can reduce your down payment with private mortgage insurance (PMI), however with a jumbo mortgage this option is not available to the borrower. Being prepared to put a 20% down payment will prepare you for the reality of a jumbo mortgage.
  • Typically, a property’s appraisal must justify the price of the property, for most jumbo mortgages 2 appraisals will be needed.

Pros

  • With this type of loan, borrowers have the opportunity to purchase a home that they couldn’t with a conventional mortgage.

Cons

  • Don’t expect a low-down payment as an option. Conventional mortgages can offer a downpayment of 3-5%, with a jumbo mortgage expect to part with at least 20% of the value of the property.
  • Jumbo loans are considered to be higher risk as they are not issued by Fannie Mae or Freddie Mac. For a conventional mortgage you may be approved with a credit score as low as 620 or even 500 with a FHA loan. With a jumbo mortgage, lenders will be expecting you to have a score of 700 or more.

If you need any further clarity on what mortgage best suits your needs, be sure to contact Jeff or one of the team members who will happily explain your options in more detail.

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