7.2 Loan Types, Lender Requirements, PMI, and Mortgage Insurance

The three loan families

A conventional loan has no government insurance or guarantee; the lender relies on the borrower's credit and the down payment. A conforming conventional loan meets Fannie Mae/Freddie Mac limits and underwriting standards; a jumbo loan exceeds those limits.

An FHA loan is insured by the Federal Housing Administration, letting lenders accept smaller down payments and lower credit scores. A VA loan is guaranteed by the Department of Veterans Affairs for eligible veterans, often with no down payment.

Note the vocabulary trap: the FHA insures and the VA guarantees — neither agency makes the loan directly; approved private lenders do.

Loan-to-value (LTV)

LTV compares the loan amount to the property's value (or price, whichever is lower):

LTV = Loan Amount ÷ Value

Worked example: a home appraises at $400,000 and the buyer borrows $320,000.

• LTV = $320,000 ÷ $400,000 = 0.80 = 80%
• Down payment = $400,000 − $320,000 = $80,000 (20%)

Higher LTV = smaller down payment = more lender risk = more likely to require mortgage insurance.

A second key number is the discount point. One point equals 1% of the loan amount, paid at closing to buy down the interest rate. On a $320,000 loan, 2 points = 0.02 × $320,000 = $6,400. Points are prepaid interest; they raise closing cash but lower the monthly payment, and as prepaid finance charges they factor into the APR.

Special and seller financing

Beyond the three main families, the exam tests niche loans by purpose and trigger:

• Reverse mortgage — lets older owners convert equity to cash; repayment is triggered when the borrower sells, moves out, or dies.
• Construction loan — short-term, disbursed in draws as work progresses, then replaced by permanent financing (a take-out loan).
• Bridge (swing) loan — short-term gap financing between buying a new home and selling the old one.
• Home equity line (HELOC) — revolving credit secured by a junior lien.
• Package loan — covers real property plus personal property (e.g., appliances).
• Blanket loan — one mortgage covering multiple parcels, with a partial-release clause freeing lots as they sell.

In seller (owner) financing, the seller carries the note. A purchase-money mortgage is seller-held financing; a contract for deed (land contract) lets the buyer take possession while the seller keeps legal title until the balance is paid.

PMI, MIP, and the VA funding fee

Private mortgage insurance (PMI) protects the lender (not the borrower) on conventional loans when the down payment is under 20% (LTV above 80%). Under the federal Homeowners Protection Act (HPA):

• A borrower may request PMI cancellation when the loan reaches 80% LTV (based on original value).
• PMI must automatically terminate at 78% LTV if the loan is current.
• PMI ends at the loan's midpoint of amortization regardless, if still in force.

FHA mortgage insurance premium (MIP) has two parts: an upfront premium (often financed into the loan) plus an annual premium collected monthly. Unlike conventional PMI, FHA MIP frequently lasts the life of the loan when the down payment is minimal — a common exam distinction.

The VA funding fee is a one-time charge (which may be financed) that replaces monthly mortgage insurance; some veterans (e.g., those with a service-connected disability) are exempt.

Qualifying ratios

Lenders test borrower capacity with debt ratios:

• Front-end (housing) ratio = PITI ÷ gross monthly income.
• Back-end (total debt) ratio = (PITI + other monthly debts) ÷ gross monthly income.

Example: gross monthly income $8,000; PITI $1,800; car + cards $600.

• Front-end = $1,800 ÷ $8,000 = 22.5%
• Back-end = ($1,800 + $600) ÷ $8,000 = $2,400 ÷ $8,000 = 30%

Repayment structures

• Fully amortized — level payments retire both principal and interest by term's end.
• Balloon — small periodic payments then one large final payment of remaining principal.
• Interest-only — pays only interest for a period; principal is unchanged.
• Adjustable-rate (ARM) — rate moves with an index plus a margin, subject to caps.
• Straight (term) loan — interest-only with full principal due at maturity.
• Growing-equity (GEM) — payments rise on a schedule, accelerating principal payoff.

Know the difference between an index and a margin on an ARM: the index is a published market rate that moves; the margin is the lender's fixed add-on. Index + margin = the note rate, restrained by periodic caps (per-adjustment) and a lifetime cap (over the loan's life).

Conforming limits, secondary market, and the Kentucky angle

Conventional loans are sorted by whether they meet Fannie Mae/Freddie Mac standards. A conforming loan fits the agencies' size limit and underwriting guidelines, so it can be sold into the secondary mortgage market; a jumbo loan exceeds the limit and usually carries a higher rate because it cannot be sold to the agencies. This secondary market — Fannie Mae, Freddie Mac, and Ginnie Mae — buys loans from originators, replenishing the cash lenders need to make new loans. The primary market is where the borrower and the originating lender meet; the secondary market is where those loans are resold to investors.

USDA Rural Development loans

A fourth program the exam sometimes adds is the USDA guaranteed loan: zero down payment for eligible buyers in designated rural areas, subject to income limits. Much of Kentucky outside its metro cores qualifies as USDA-eligible territory, so a Kentucky-flavored item may pair "rural Kentucky property" with "no-down-payment government-backed loan" pointing to USDA rather than VA.