By Douglas Katz
I had a very interesting discussion with a client last weekend, which inspired me to write this piece. I was sitting with the client and a trusted friend that she had brought along for moral support. The meeting was to discuss refinance options during her divorce. We covered the basic types of loans, but because she was not yet divorced one of the options was a portfolio loan. As I will cover later, these loans have a much different set of guidelines and pricing than the traditional mortgage, which can be very confusing. As a result, we spent a good amount of time covering these differences and the benefits, and in some cases, the drawbacks of each type of loan. I, therefore, thought it made sense to spend some time explaining the different types of loans and how they will impact you in a divorce.
The first and most common types of that you will likely consider are conventional loans, which can be broken down into conforming and non-conforming. Conforming loans are the type that are purchased by Fannie Mae and Freddie Mac. Because of this, they usually have the most stringent documentation requirements and underwriting guidelines, which includes a loan limit. Non-conforming loans are still considered conventional and very similar to conforming, but usually allow for small variances not covered in the Fannie Mae/Freddie Mac world such as higher loan amounts. The most important thing to remember with these types of loans are that they are generally black and white from an underwriting perspective to make the loans salable to Fannie Mae, Freddie Mac or other investors. The advantage is that with this salability comes the best terms and pricing. When looking to use conventional financing during or after your divorce, you need plan out the process to ensure that your divorce decree and other components of your divorce align with the guidelines. Small mistakes can and often do invalidate conventional loans as an immediate option.
Second and also very prevalent in the lending marketplace are government loans. These are FHA, VA and USDA. All of these are backed by the US Government and were created to fill a niche or to meet the need of a specific group, such as veterans with the VA loan. The advantage with these loans is that there is usually some flexibility over conventional loans. As an example, both VA and FHA allow for a lower down payment that their conventional counterparts. That is not to say that they are completely subjective, because like conventional loans, government loans are tied to a broader set of guidelines to which a lender must adhere. The difference is that these guidelines are often superior for clients with specific lending needs like a low down payment or a higher debt ratio. As with conventional loan, if you intend to use a government loan then financing a home during or after a divorce, you need to properly plan out the process to ensure that you qualify.
Finally, there are portfolio and non-prime loans. These loans differ from conventional an government loans in many ways, but the key difference is that while the two previously mentioned loans types are originated to be sold, portfolio and non-prime loans are not. As a result, they are not bound by the guidelines and documentation requirements that sometimes make conventional and government loans a challenge during a divorce. The institutions originating the loans still expect applicants to be a decent credit risk and they must adhere to regulations like fair lending, but because they are not worried about salability, they determine the credit profile to which they want to lend. In the case of divorce, this means that you can gain access to more and possibly better options. With this flexibility usually comes a higher price, however. Since the originating institutions are unable to sell these loans, mortgage of these types present more risk and they will charge a higher rate as compensation for that risk.
The important thing to remember is that none of these loan types is the unequivocal perfect solution. A lot depends on what you want to accomplish beyond the basics of retaining the home or buying a new one. Such things as your timeline, your credit score, your income before and after the divorce and the home itself have a significant impact on the right solution for you. Unless you have broad based knowledge of the mortgage lending, there is no way for you to know what is available, so finding that solution can be extremely difficult. I always encourage anyone considering a divorce or entering into one where a mortgage is involved to engage the help of a experienced and certified divorce mortgage professional to assist as navigating the complexity of a divorce, evaluating the lending options and selecting the best one to give you a new start.