Financing Basics For Maui Real Estate

There are numerous financing options for homebuyers which at times can seem overwhelming. Take your time, and research the basics of financing property on Maui and you can save you a significant amount of time and money. Knowing the Maui Market, the area the property is located, and whether it offers incentives to lenders will mean added financial perks for you. Know your finances to ensure you are getting the mortgage that best suits your needs and budget.

Key Points

Obtaining a mortgage is a crucial step in purchasing your Maui home, whether it's a beachfront Maui condo or single-family home in a popular Maui neighborhood, there are many factors for choosing the mortgage that suits you best.

Lenders will evaluate your credit, income, past tax returns, assets, and ability to borrowed funds.

When choosing a mortgage, you'll have to choose a fixed or floating rate, the term (number of years) to pay off your mortgage, and the amount of your down payment.

Depending on your finances, employment, and other factors, you may be eligible for better terms through an FHA or VA loan process.

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Types of Loans

Conventional loans are mortgages that are not insured or guaranteed by the federal government. They are typically fixed-rate mortgages. Although their stricter requirements for a bigger down payment, higher credit score, lower-income to debt ratios, and potential to need private mortgage insurance make them the most difficult to qualify for, conventional mortgages are usually less costly than guaranteed mortgages.

Conventional loans are defined as either conforming loans or non-conforming loans. The 2020 loan limit for a conventional mortgage is $726,525 in Hawaii.

A loan made above $726,525 in Hawaii is called a jumbo loan and usually carries a higher interest rate. For non-conforming loans, the lending institution underwriting the loan, usually a portfolio lender, set their own guidelines.

Conforming Loan Limits in Maui

The Federal Housing Finance Agency (FHFA), Fannie Mae, and Freddie Mac recently announced the maximum conforming loan limits for 2022.*

In Hawaii (including Maui County), the 2022 maximum conforming loan limit for one-unit properties will be $970,800.

Here is a map showing the conforming loan limits in all 50 states for 2022. Click Here

FHA Loans

The Federal Housing Administration (FHA), part of the U.S. Department of Housing and Urban Development, provides various mortgage loan programs. An FHA loan has lower down payment requirements and is easier to qualify for than a conventional loan. FHA loans are excellent for first-time homebuyers because, in addition to lower upfront loan costs and less stringent credit requirements, you can make a down payment as low as 3.5%.3 FHA loans cannot exceed the statutory limits described above.

The catch? All FHA borrowers must pay a mortgage insurance premium (MIP), rolled into their mortgage payments (see private mortgage insurance, below).

VA Loans

The U.S. Department of Veterans Affairs (VA) guarantees VA loans.4 The VA does not make loans itself, but guarantees mortgages made by qualified lenders. These guarantees allow veterans and service people to obtain home loans with favorable terms, usually without a down payment. In most cases, VA loans are easier to qualify for than conventional loans. Lenders generally limit the maximum VA loan to conventional mortgage loan limits. Before applying for a loan, request eligibility from the VA. If you are accepted, the VA will issue a certificate of eligibility you can use to apply for a loan.

If you intend to use a VA Loan to purchase a condo on Maui the unit must be approved by the VA. View the list of VA-approved condos on Maui.

In addition to these federal loan types and programs, state and local governments and agencies sponsor assistance programs to increase investment or homeownership in certain areas.

Financing in Maui

Equity and Income Requirements

Home mortgage loan pricing is determined by the lender in two ways, both based on the creditworthiness of the borrower. In addition to checking your FICO score from the three major credit bureaus, lenders will calculate the loan-to-value ratio (LTV) and the debt-service coverage ratio (DSCR) to set the amount they'll loan you, and the interest rate.

LTV is the amount of actual or implied equity that is available in the collateral being borrowed against. For home purchases, LTV is determined by dividing the loan amount by the purchase price of the home. Lenders assume that the more money you are putting up (in the form of a down payment), the less likely you are to default on the loan. The higher the LTV, the greater the risk of default, so lenders will charge more.

Private Mortgage Insurance

LTV also determines whether you will be required to purchase private mortgage insurance (PMI). PMI insulates the lender from default by transferring a portion of the loan risk to a mortgage insurer. Most lenders require PMI for any loan with an LTV greater than 80%, meaning any loan where you own less than 20% equity in the home.7 The amount being insured and the mortgage program will determine the cost of mortgage insurance and how it's collected.

Most mortgage insurance premiums are collected monthly along with tax and property insurance escrows. Once LTV is equal to or less than 78%, PMI is supposed to be eliminated automatically. You may be able to cancel PMI once the home has appreciated enough in value to give you 20% equity and a set period has passed, such as two years. Some lenders, such as the FHA, will assess the mortgage insurance as a lump sum and capitalize it into the loan amount. As a rule of thumb, try to avoid private mortgage insurance, because it is a cost that has no benefit to you.

There are ways to avoid paying for PMI. One is not to borrow more than 80% of the property value when purchasing a home; the other is to use home equity financing or a second mortgage to put down more than 20%. The most common program is called an 80-10-10 mortgage.8 The 80 stands for the LTV of the first mortgage, the first 10 stands for the LTV of the second mortgage, and the third 10 represents the equity you have in the home.

Although the rate on the second mortgage will be higher than the rate on the first, on a blended basis, it should not be much higher than the rate of a 90% LTV loan. An 80-10-10 mortgage can be less expensive than paying for PMI and also allows you to accelerate the payment of the second mortgage and eliminate that portion of the debt quickly so you can pay off your home early.

Fixed vs. Floating Rate Mortgages

Another consideration is whether to obtain a fixed-rate or floating-rate (or variable rate) mortgage. In a fixed-rate mortgage, the rate does not change for the entire period of the loan. The obvious benefit of getting a fixed-rate loan is that you know what the monthly loan costs will be for the entire loan period. And, if prevailing interest rates are low, you've locked in a good rate for a substantial time.

A floating-rate mortgage, such as an interest-only mortgage or an adjustable-rate mortgage (ARM), is designed to assist first-time homebuyers or people who expect their incomes to rise substantially over the loan period. Floating-rate loans usually allow you to obtain lower introductory rates during the initial few years of the loan, allowing you to qualify for more money than if you had tried to get a more expensive fixed-rate loan. Of course, this option can be risky if your income does not grow in step with the increase in interest rate. The other downside is that the path of market interest rates is uncertain: If they dramatically rise, your loan's terms will skyrocket with them.

How ARMs Work

The most common types of ARMs are for one, five, or seven-year periods.9 The initial interest rate is normally fixed for a period of time and then resets periodically, often every month. Once an ARM resets, it adjusts to the market rate, usually by adding some predetermined spread (percentage) to the prevailing U.S. Treasury rate. Although the increase is typically capped, an ARM adjustment can be more expensive than the prevailing fixed-rate mortgage loan to compensate the lender for offering a lower rate during the introductory period.

Interest-only loans are a type of ARM in which you only pay mortgage interest and not principal during the introductory period until the loan reverts to a fixed, principal-paying loan. Such loans can be very advantageous for first-time borrowers because only paying interest significantly decreases the monthly cost of borrowing and will allow you to qualify for a much larger loan. However, because you pay no principal during the initial period, the balance due on the loan does not change until you begin to repay the principal.

The Bottom Line

If you're looking for a home mortgage for the first time, you may find it difficult to sort through all the financing options. Take time to decide how much home you can actually afford and then finance accordingly. If you can afford to put a substantial amount down or have enough income to create a low LTV, you will have more negotiating power with lenders and the most financing options. If you push for the largest loan, you may be offered a higher risk-adjusted rate and private mortgage insurance.

Weigh the benefit of obtaining a larger loan with the risk. Interest rates typically float during the interest-only period and will often adjust in reaction to changes in market interest rates. Also, consider the risk that your disposable income won't rise along with the possible increase in borrowing costs.

A good mortgage broker or mortgage banker should be able to help steer you through all the different programs and options, but nothing will serve you better than knowing your priorities for a mortgage loan.

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