Conforming Mortgage Guidelines Versus Government Loans
This article covers Conforming Mortgage Guidelines Versus Government Loans
FHA loans, VA loans, USDA loans are often called government loans. This is because lenders who originate these types of home loans are guaranteed by the government.
- FHA loans are insured by the Federal Housing Administration, a subsidiary of the United States Department of Housing and Urban Development
- VA loans are guaranteed by the Department of Veteran Affairs
- In the even if homeowner defaults on an FHA loan, the Federal Housing Administration will insure the lender who originated the FHA loan against loss
- Same with VA loans
- If the borrower defaults on a VA loan and goes into foreclosure, the lender who originated the VA loan goes into default, the Department of Veteran Affairs will guarantee lender who originated the VA loan the loss
- The concept is the same as USDA loans
- If the USDA loan goes into default, the lender who originated the USDA loan will get insured by USDA
- Any mortgage loans that are not backed and insured by a government entity is called a conventional loan
Role Of Fannie Mae And Freddie Mac
Conventional loans conform to Fannie Mae or Freddie Mac lending guidelines.
- Fannie Mae and Freddie Mac are also known as Government Sponsored Enterprises, GSE, and are corporations which were created by the federal government
- The role of Fannie Mae and Freddie Mac to purchase home loans that meet their guidelines from mortgage lenders throughout the country
Lenders package them up as Mortgage-Backed Securities ( MBS ) and re-sell them to Wall Street and institutional investors on the secondary market.
Conventional Loan Basics
To qualify for government loans, borrowers need to follow the government agency that is insuring the government loan.
For example, if the borrower wants an FHA loan, lenders require they follow FHA guidelines such as the following:
- 3.5% minimum down payment
- 46.9%/56.9% debt to income ratios
- minimum of 580 credit scores
- 2-year employment history
- 2-year residential history
- other minimum FHA lending guidelines
With conventional loans, borrowers need to follow Fannie Mae lending guidelines.
How Do Conforming Loans Work
Many borrowers question why they need to follow any conforming mortgage guidelines if conventional loans are not guaranteed or insured by the federal government:
The reason they need to follow Fannie Mae or Freddie Mac conforming mortgage guidelines due to the following case scenario:
- the lender initially funds the conventional loan
- the lender then re-sells the conventional loan to Fannie Mae or Freddie Mac
- they can unload their warehouse line of credit
- this way they can re-use their warehouse line of credit to fund other conforming loans
In order for Fannie Mae or Freddie Mac to purchase mortgage loans from private mortgage lenders, the loans need to meet Fannie Mae and/or Freddie Mac conforming mortgage guidelines.
Pros And Cons Of Conforming Loans
One of the greatest advantages of a conventional loan is that there is no private mortgage insurance with a 20% down payment on a home purchase. Or 80% loan to value on a refinance mortgage.
- FHA loans require an upfront mortgage insurance premium of 1.75%
- HUD also requires a lifetime 0.85% annual FHA mortgage insurance premium which can be quite costly
- Cannot cancel the FHA mortgage insurance premium no matter how low the loan to value is on 30 year fixed rate mortgages
- The only way of eliminating annual FHA MIP is to pay off or refinance a 30-year fixed rate FHA Home Loan
- With conventional loans, private mortgage insurance is required for any mortgages with higher than 80% loan to value
- Annual private mortgage insurance is required on conforming loans with less than 20% equity
- Can request private mortgage insurance be canceled once the property meets 80% loan to value
A new appraisal will be required unless the homeowner pays down the loan balance.
Conforming Mortgage Guidelines And Requirements
Conventional loans have tougher lending guidelines than government loans:
- Minimum down payment required to qualify for a conventional loan is 5%
- FHA where the minimum down payment is 3.5%
- Minimum credit scores to qualify for a conventional loan is 620
- FHA loans, the minimum credit score is 580
- The maximum debt to income ratios are capped at 50% with conventional loans
Cap on FHA loans is 46.9% front end and 56.9% back end DTI to get an automated underwriting system approval.
Conforming Guidelines After Bankruptcy And Housing Event
Conforming Mortgage Guidelines with regards to a waiting period after a bankruptcy, foreclosure, deed in lieu of foreclosure, or a short sale are much stricter with conventional loan programs than with FHA loans.
- Borrowers need to wait 4 years after Chapter 7 bankruptcy to qualify conforming loans
- FHA, VA, USDA requires a 2-year waiting period after Chapter 7 Bankruptcy discharged date
- VA Loans have 2-year waiting period requirements after housing event (foreclosure, deed in lieu of foreclosure, short sale)
- Conforming Mortgage Guidelines requires 7 years to qualify for a conventional loan after a foreclosure
- FHA and USDA Loans require three years to qualify after a foreclosure
- Conforming Mortgage Guidelines requires four years after a short sale and/or deed in lieu of foreclosure to qualify for conventional loans
- There is a three year waiting period after a short sale and/or deed in lieu of foreclosure to qualify for FHA and USDA Home Loans
- The U.S. Department of Veteran Affairs (VA) has a two-year waiting period after Chapter 7, foreclosure, deed in lieu of foreclosure, short sale
The bottom line is borrowers great credit and a strong financial profile, the conventional loan route is the best way to go. Those with weaker credit and financial profiles, FHA loans will probably the best route to take and eventually refinance their FHA loan into a conventional loan. The most important benefit of conventional loans over FHA loans is due to the mortgage insurance premium.