Understanding Mortgage Categories

Tim Milazzo
December 9, 2020

If you haven’t been involved in a wide swath of different types of real estate deals, it’s really easy to be confused about the different types of mortgage loans. You have conforming and non-conforming loans for home buyers, and commercial mortgages for the largest real estate investors. So where does “jumbo” fit in the mix? What about investors buying a single family rental? Is multifamily just considered a part of commercial?

Let’s simplify this:

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Mortgages for Home Owners

The most common type of mortgage is designed to help a consumer buy a home to live in. There are two broad categories these fit into.

Conforming Mortgages

Conform | verb

to comply with rules, standards, or laws.

A conforming loan is one that fits a standard mold, so to speak. So what standards does this type of loan conform to? And who decides on those rules?

In the US, rules for a conforming loan are set by two different government-sponsored entities: the Federal National Mortgage Association (known as “Fannie Mae”) and the Federal Home Loan Mortgage Corporation (known as “Freddie Mac”). A conforming loan would be one that passes all of the underwriting guidelines of either agency.

So what does it take to conform?

Conforming Loan Standards for Fannie Mae and Freddie Mac

  • Minimum Credit Score: 620
  • Maximum Debt-to-Income (DTI): 50%
  • Maximum Loan-to-Value (LTV): 97%
  • Maximum Loan Amount (see below)

In 2021, the conforming loan limits are as follows:

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Note: there are exceptions to these limits for areas with higher cost of living. Speak with a residential mortgage expert to learn more.

Why it matters

Conforming loans typically have lower interest rates than nonconforming loans, since these federal agencies package and insure the loans that fit their program.

Non-conforming Mortgages

A non-conforming mortgage loan would be anything that does not fit any of the standards laid out above.

A word on Jumbo loans

“Jumbo” would refer to any loan that exceeds the maximum borrowed amount for a Conforming mortgage. This does not necessarily mean that a mortgage is inherently more or less risky than a Conforming mortgage, it just means it’s too large to be insured by Fannie Mae or Freddie Mac.

A word on Subprime loans

Subprime would be loans for less credit-worthy borrowers. You may associate the term with the Subprime Mortgage Crisis, which was one of the key factors in the “Great Recession” of 2008. A subprime borrower has a spotty history of paying their debts, making lending to these individuals more risky.

Residential Investment Loans

1–4 unit residential properties purchased by an individual as an investment are eligible to be financed by a residential mortgage, so see above about Conforming or Non-conforming mortgages.

However, if that property is purchased by multiple equity partners, or if the investment is to be held in an LLC, then the borrower is required to use a commercial mortgage.

Commercial mortgages for these 1–4 family investment properties typically require at least 20% down payment.

Commercial mortgages

A commercial mortgage is any loan collateralized by a commercial property, which includes all multifamily properties or portfolios that total 5 or more units.

Commercial mortgages are an entirely different financial product than residential, with the only defining similarity coming through the fact that they collateralize real property. Commercial mortgages may include prepayment penalties, recourse to the borrower after financial default, and other structures not typically seen in a residential loan.

“Agency” loans through Fannie Mae or Freddie Mac

Here we are with Fannie Mae and Freddie Mac again. I know, it’s confusing. But these agencies also insure Multifamily mortgages, which is completely separate from all the “conforming” stuff we covered above.

Agency loans are Securitized, meaning the lender ultimately pools these types of loans together and sells them off in pieces to bond investors. Securitized loans are Non-recourse, and agency loans in particular typically feature 30 year amortization. It’s very popular for stabilized multifamily properties to be financed with agency debt.

  • Property: 5+ unit Multifamily
  • Minimum Loan Size: $1 Million
  • Minimum Borrower Credit Score: 680
  • Minimum Borrower Net Worth: ≥ Loan Size
  • Minimum Borrower Liquidity: 9 months of loan payments after closing

Commercial Mortgage Backed Securities (CMBS)

CMBS loans are loans that are sold out to the bond market without federal agency insurance from the likes of Fannie, Freddie, or HUD. As such, these are not constrained to Multifamily properties. Offices, retail centers, industrial buildings, and even hotels can all receive financing via CMBS.

CMBS issuers are required to hold 5% of the loan or loan pool they distribute, and that is very often all that they do hold. Once you take on a CMBS loan, you’ll then be passed off to a third party who services the loan, and represents the bond investors.

Banks and credit unions

Banks and credit unions usually hold loans they originate on their balance sheet. This means that your lender will keep ownership of the loan, and you can still correspond directly with the same institution if you have issues with your loan later.

Banks more typically offer Recourse financing, meaning they expect to be paid back in full, even if the property is “under water”. The borrower would need to make up the difference from their personal finances.

Life Insurance Companies (“Life Co”)

Many life insurance companies offer long-term financing for commercial real estate. They are typically not the most aggressive on leverage, but are known to have some of the lowest interest rates in the industry. Life Cos, as we typically refer to them, almost always hold loans on their books after originating.

Debt Funds

These are private pools of money organized expressly for lending. Debt funds are typically more expensive with rates and fees, but offer more flexible terms or more lenient underwriting than the other types of lenders above. Debt funds can either keep the loans, or sell them off in whole or in parts.

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