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Unique Mortgages: Uncommon Ways to Finance

04/04/2019 Jerrica Farland

LOAN TYPES BUYING A HOME

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All mortgages are not created equal and that, of course, is by design. Special circumstances require special lending packages. Enter the odd ducks—mortgages created for very specific circumstances. But what exactly are these loans?

They include loans to help you bridge the gap between the sale of your old home and the purchase of your new home, loans to pay for construction or repairs, “green mortgages” to help make your house more energy efficient, and subordinate or junior mortgages. There are a variety of lesser-known lending options designed to fit specific needs.

Anyone who has ever bought, sold, built, or renovated a house knows that it’s more complicated than simply signing on the dotted line. Fortunately, if you find yourself in a situation where a traditional mortgage won’t suit your specific needs, there are a variety of loan options to help you finance your future. Here is a look at some of the less common lending options available to borrowers.

Bridge Loans

Whether you are upgrading to make room for a growing family or downsizing to accommodate an empty nest, the process of buying a new home while selling your current residence comes with an inherent set of financial challenges. If your current home hasn’t sold yet, it can often be difficult to come up with a down payment for the mortgage on your future home.

One solution to this problem is for a buyer to put in a contingency offer on their new home, making the offer dependent on the sale of the buyer’s old home. While this may make things easier for the buyer, it can be less attractive to the seller because a contingency come with uncertainty.

With a bridge loan, the buyer can take out a loan against their existing property, to bridge the gap between the purchase of the new home and when the old home sells. The bridge loan provides the borrower the down payment that would have been provided by the equity on the old home before the sale of that home.

This is especially useful for buyers in competitive markets that will need to act quickly when they find the right property. A bridge loan will allow the buyer to make an offer without any strings attached, allowing them to remain competitive and act decisively in a crowded field. There may be additional qualifying requirements to obtain a bridge loan.

Shopping for property in a competitive market? Here are five strategies to help you succeed

Combination Loans

While 20% is not required to obtain a home loan, some prefer not to have mortgage insurance. Borrowers who don’t have enough cash on hand to cover the 20% down payment associated with conventional mortgages are usually required to carry private mortgage insurance (PMI). Mortgage insurance is typically paid as a monthly premium in addition to the principal, interest and taxes on a home loan; it’s usually lumped into the regular monthly mortgage payment. However, those who don’t want MI and who qualify can use a combination loan to avoid paying the extra expense of PMI by splitting their debt into two separate loans.

Want to know more about Private Mortgage Insurance? Learn how PMI can lower your down payment.

For example, a buyer needs financing for a $300,000 home, but only has enough cash on hand for a 10% down payment. Using a combination loan, the buyer can split the remaining 90% of the purchase price across two separate loans:

  • Down Payment: $30,000
  • Loan 1: $240,000
  • Loan 2: $30,000
  • Total:$300,000

The first loan covers 80% of the total cost (and will generally have a lower interest rate), the down payment covers 10%, and the second loan covers the remaining 10%. A combination loan in this configuration is also called an 80-10-10 loan, or an 80-10-10 piggyback loan.

Construction Loan Mortgages

What about buyers who want a new home, but would rather start from scratch and build a brand new one? Since you can’t take out a mortgage on a home that doesn’t exist yet, money to cover the cost of labor and materials will need to be financed by other means.

The main consideration with construction loans is that they are short-term loans. Typically, a construction loan will have a higher interest rate that moves up and down with market interest rates. During the construction time frame, usually less than a year—the borrower may not make payments or in some cases, make interest-only payments. There are two main types of construction loans, combination loans for construction, and stand-alone construction loans.

Single Close Construction to Perm, or Combination Loans for Construction

A combination loan for construction combines a short-term loan to pay for construction with a traditional mortgage. Once the new home is completed, the construction loan is converted or modified into permanent financing and the borrower begins making full payments. The benefit to a construction combination loan is that by obtaining one loan to cover both construction and long term financing through the same lender, the borrower saves on closing costs and is typically only required to qualify for the loan one time.

Stand-Alone Construction Loan

Not all borrowers who are building new homes will want to combine two loans from one lender. In some situations, a stand-alone construction loan is the better option. This loan is exactly what it sounds like: a loan used to pay for the construction of a new home. Once the construction is complete, the borrower will need to refinance and take out a new loan to pay off the balance.

When the construction loan is not modified into permanent financing, the borrower will have to pay separate fees for both the construction loan and the permanent mortgage and may have to qualify twice, once for the construction loan and once for the permanent financing. A stand-alone construction loan, however, generally requires a much lower down payment.

FHA 203(k) Loan

For buyers who would rather customize a fixer-upper with good bones than start from scratch, a different loan is in order. The FHA 203(k) loan is similar to a combination loan, in that it is essentially two loans in one: a loan for the purchase price of the home, combined with a loan to pay for repairs.

A 203(k) loan is a type of FHA loan, which comes with its own set of criteria:

  • In general, FHA loans are designed for first-time homebuyers or borrowers who would otherwise not qualify for a conventional loan, making it easier to obtain than a construction loan.
  • FHA 203(k) loans must be originated through an FHA-approved lender.

Examples of repairs that qualify for a 203(k) loan range from smaller improvements, such as painting or flooring renovations, to larger projects, such as improving accessibility or connecting to a public sewer or water lines.

There are two types of 203(k) loans, 203(k) Standard, and the 203(k) Streamline.

The 203(k) Standard loan is for bigger repairs such as structural improvements or adding new rooms, and requires a more involved application process and requires hiring a 203(k) consultant.

The 203(k) Streamline loan is designed for smaller improvements, with a minimum improvement amount of $5,000, and a maximum of $35,000 (or up to 110% of the price of the home). Construction must be completed within six months, and the home can’t be vacant for more than 30 days.

In general, as long as the loan is being used for non-luxury, permanent improvements, there is a good chance that one of the two loans will fit the bill.

Energy Efficient Mortgage

Repairs and improvements will often increase your home’s value, but when those improvements also make your home more energy efficient, they can actually lower your monthly expenses. An Energy Efficient Mortgage (EEM) is a loan that allows the borrower to finance energy-saving improvements as part of a single mortgage. EEMs are available for a variety of borrowers, including those buying, refinancing, remodeling, or selling.

For a new home buyer, an EEM can be a great way to increase the net value of a home without needing to be approved for a larger mortgage. For example, an EEM can allow a family that has been approved for a $250,000 mortgage to purchase a home in that price range and then make energy-saving improvements beyond the original $250,000, thus increasing their borrowing power. Qualifying improvements, such as new windows, insulation, and a modern HVAC system will not only lower monthly energy costs, but also increase the value of the property. Note that, depending on the amount of improvements, you may need to show the savings in energy consumption to qualify.

There are several varieties of EEMs, and various ways to take advantage of their cost-saving benefits. For more detailed info, see the Housing and Urban Development (HUD) site.

Subordinate Mortgages or Junior Mortgages

Most mortgages taken out to finance the purchase of a home will include a subordination clause. What this clause entails is that any additional loans taken out on the property will be subordinate, or junior, to the first, or senior, loan. Meaning, the senior loan will have priority over any additional loan that comes after it.

There are several types of subordinate mortgages. Some combination loans include a subordinate mortgage, such as the 80-10-10 type of combination loan discussed above, where a borrower takes out two separate loans to avoid PMI. In that case, the smaller mortgage (for 10% of the purchase price) will be subordinate to the larger loan.

Other types of subordinate mortgages will originate after the home has been purchased and the borrower has started making payments on their first mortgage. The process of paying off a home loan builds equity. This equity—that is, the portion of the loan that the borrower has already paid back—can be used as collateral to borrow more money. This second loan is a type of subordinate or junior mortgage, for example a home equity loan.

Other types of subordinate mortgages will originate after the home has been purchased and the borrower has started making payments on their first mortgage. The process of paying off a home loan builds equity. This equity—that is, the portion of the loan that the borrower has already paid back—can be used as collateral to borrow more money. This second loan is a type of subordinate or junior mortgage, for example a home equity loan.

A borrower might use this type of subordinate loan to pay off debt with a higher interest rate, e.g., credit card debt, or to cover emergency expenses, such as medical bills not covered by insurance. It’s important to remember, however, that just like a first mortgage, defaulting on a subordinate mortgage may lead to foreclosure.

Want to know about all types of mortgages? Check out our mortgage glossary.

Which Loan Is Right For You?

Whether you are buying, selling, building, or fixing a home, one thing is for sure— it is going to cost money, and when it comes to loans, there are plenty of options. Fortunately, the experts at PennyMac are here to help. If you have questions about the loans PennyMac offers or need help finding the best mortgage to fit your needs, contact a PennyMac Loan Officer.