FHA Loan: Conventional Loan Versus FHA Loan

The Federal Housing Administration guarantees residential mortgage loans to FHA approved mortgage lenders.  FHA loans are an excellent mortgage loan program for first time home buyers and makes the dream of home ownership possible to those first time home buyers and seasoned home buyer who need a home loan with bad credit.  FHA loan programs are different than conventional loan programs.  FHA loan mortgage lending guidelines are much easier than conventional loan mortgage lending guidelines.  There are much more advantages with FHA loan programs than there is with conventional loan programs.  However there are cases where a mortgage loan borrower needs to go with a conventional loan instead of a FHA loan, which we will discuss later in this article.

Basic FHA Loan Program Lending Guidelines

The Federal Housing Administration created the FHA loan program to make home ownership possible to all hard working Americans.  FHA loans are extremely popular for first time home buyers and seasoned home buyers.  FHA loan programs are the mortgage choice for those seeking a home loan with bad credit.  A first time home buyer or home buyer that needs a home loan with bad credit can qualify for a FHA loan with a credit score as low as 530 FICO.  For home buyers who need a home loan with bad credit and who has credit scores between 530 FICO and 580 FICO credit scores can qualify for a FHA insured mortgage loan as long as they can put a 10% down payment.  For those who can only put a 3.5% down payment, the mortgage loan borrower needs a credit score of at least a 580 FICO credit score.  Home buyers who need a home loan with bad credit, a FHA loan is the perfect mortgage loan program for them.

Benefits Of FHA Loans

Here are some other advantages for first time home buyers and home buyers in getting a FHA loan:

1.  Minimum credit score of 530 FICO.  If you need a home loan with bad credit and your credit scores fall between 530 FICO and 580 FICO credit scores, you need a 10% down payment.  Debt to ratio caps are 31% front end debt to income ratio and 43% back end debt to income ratio.

2.  To qualify for a 3.5% down payment FHA loan, your credit scores needs to be 580 FICO minimum.  Those with credit scores of under 620 FICO, the debt to income ratio caps are the following:  31% front end debt to income ratio, 43% back end debt to income ratio.  For those whose credit scores are 620 FICO or higher, the front end debt to income ratio cap boosts to 46.9% and the back end debt to income ratio is 56.9%.

3.  Non-occupant co-borrowers are allowed on FHA insured mortgage loans.  The borrower does not to provide any income as long as he or she has a non-occupant co-borrower.  The non-occupant co-borrower needs to be a family member or a member that is related to the borrower by blood, marriage, or law.

4.  100% of the down payment funds can be gifted.  A gift letter certifying that the gift funds is not a loan and a 100% gift that will not be paid back needs to be signed by both parties.  All gift funds needs to be sourced where the funds leaving the donor’s account into the recepient account needs to be sourced by providing bank account information by both the donor and recepient.  Normally, mortgage lenders want to see a 30 day seasoning of the gift funds from the donor’s bank statement.

5.  Open collections and unsatisfied derogatory credit is allowed per FHA mortgage lending guidelines.  Open collections and unsatisfied debts do not have to be paid unless it is a judgment, government loans, tax liens, or child support and/or alimony payments.  Judgments and tax liens are allowed as long as the mortgage loan borrower has a written payment agreement and has been paying the judgment creditor or the IRS three months of payment and can provide three months of cancelled checks.

6.  Those who seek a home loan with bad credit and have a prior bankruptcy, foreclosure, deed in lieu of foreclosure, short sale can qualify for a FHA loan after meeting waiting period mortgage lending guidelines:  For a bankruptcy, the home buyer needs to meet two years waiting period after a bankruptcy.  For foreclosure and deed in lieu of foreclosure, the home buyer needs to wait three years from the sheriff’s sale or the recorded date of the foreclosure.  For a short sale, the home buyer needs to wait three years from the date of the short sale which is reflected in the HUD’s Settlement Statement.   Re-established credit and no late payments after the period of derogatory period has lapsed is mandatory.

7.  FHA Back to Work Extenuating Circumstances due to an economic event:  HUD has launched the FHA Back to Work Extenuating Circumstances due to an economic event mortgage loan program which has shortened the waiting period to a one year waiting period for those home buyers who had a prior bankruptcy, foreclosure, deed in lieu of foreclosure, short sale.  To qualify for the FHA Back to Work Extenuating Circumstances due to an economic event mortgage loan, the home buyer needs to have been unemployed or underemployed for at least six months prior to the initiation of the bankruptcy, foreclosure, deed in lieu of foreclosure, or short sale sale.  The disadvantage of having a conventional loan versus a FHA loan is that conventional mortgage loan programs do not offer shortened waiting periods after a bankruptcy, foreclosure, deed in lieu of foreclosure, or short sale.  Conventional loan versus FHA loan:  With conventional loan programs, the waiting period is 7 years from the date of the bankruptcy discharge or recorded date of the foreclosure in order to qualify for a conventional mortgage loan.  If you are a first time home buyer or seasoned home buyer in Illinois, Florida, Wisconsin, California, or Indiana and are looking for a home loan with bad credit and are interested in the new FHA Back to Work Extenuating Circumstances due to an economic event mortgage loan, please contact me at 262-716-8151 or at www.gustancho.com .

8.  FHA allows up to a 6% sellers concession towards a buyers closing costs credit.  Conventional loan program allows only a 3% maximum sellers concession credit towards a buyers closing costs.

9.  Mortgage insurance premium:  A big disadvantage of not having a conventional loan versus FHA loan is that FHA loan programs have FHA mortgage insurance premium that is not cheap.  FHA loan programs automatically charge a 1.75% upfront mortgage insurance premium on all FHA loan programs.  This upfront mortgage insurance premium is added on top of the initial FHA loan balance.  FHA loan programs also charge a monthly FHA mortgage insurance premium of 1.35% of the balance of the FHA loan and this is paid for the lifetime of the 30 year FHA insured mortgage loan.  You cannot cancel this annual 1.35% FHA mortgage insured premium.  For 15 year fixed rate FHA loans, the 1.75% upfront mortgage insurance premium is still charged but the annual mortgage insurance premium is reduced to 0.45% of the FHA mortgage balance if the FHA mortgage loan borrower can put a 10% down payment.  One major advantage of conventional loan versus a FHA loan is that there is no private mortgage insurance on conventional loans where a home buyer puts down 20% down payment and but private mortgage insurance is required on conventional loans for home buyers that put a down payment of less than 20% down payment on a home purchase.  The advantage of conventional loan versus FHA loan is that the annual private mortgage insurance premium is much less than those of FHA loan mortgage insurance premium.  Conventional loan private mortgage insurance premiums are about half of those of FHA mortgage insurance premium of 1.35%.

10.  A huge advantage with FHA loans is that a 2 to 4 unit multi family unit home buyer can just put a 3.5% down payment on a multi family unit home purchase where with conventional loans require 15% down payment.

11.  FHA loans are for owner occupant home purchases only.  If you are interested in purchasing a second home, vacation home, or investment home, you need to go with a conventional loan.

Conventional Loan Versus FHA Loan: Conventional Loans

Conventional loans are totally different than FHA loans.  First of all, to qualify for a conventional loan, the conventional mortgage loan borrower needs a minimum credit score of 620 FICO.  FHA loan mortgage rates are not credit sensitive.  Anyone with a 640 FICO or greater credit score will get the best FHA mortgage rates.  However,  a difference between conventional loan versus FHA loan is that with conventional loans, mortgage rates are credit score driven.  The lower your credit score, the higher your mortgage rate will be.  To get the best conventional mortgage rate, you need to have credit scores of over 760 FICO.  Every 20 point increments yields a higher mortgage rate.  The breakdown on mortgage rates are 760 FICO, 740 FICO, 720 FICO, 700 FICO, 680 FICO, 660 FICO, 640 FICO, and 620 FICO.  For those with credit scores of 620 FICO can expect a high mortgage rate if they are seeking a conventional loan.

Down Payment Requirements On Conventional Loans Versus FHA Loans

A disadvantage of conventional loan versus FHA loan is that conventional loans require a minimum 5% down payment versus the 3.5% minimum down payment.  Conventional loan programs do not allow for non-owner occupant co-borrowers like FHA insured mortgage loans do.  Another disadvantage on conventional loan versus FHA loan is that 100% gift funds is not allowed for a home purchase down payment.  Gift funds are allowed on conventional loans but are limited.  Conventional mortgage lenders want the home buyers to put some skin in the game.  For example, a conventional mortgage lender may allow the home buyer to put down a 3% down payment and allow a 2% gift funds from a family member.  Another disadvantage with conventional loan versus FHA loan is that if you are a home buyer of a 2 to 4 unit multi unit property, 15% minimum down payment is require where FHA only requires a 3.5% down payment on a 2 to 4 unit multi family property home purchase.

Conventional Loan After Foreclosure

A disadvantage with conventional loan versus FHA loan is that there is a mandatory 7 year waiting period after a bankruptcy and/or foreclosure to qualify for a conventional mortgage loan.  FHA insured mortgage loan programs have shorter waiting periods after a person has filed bankruptcy and/or foreclosure.

Conventional Loan Versus FHA Loan: Cases Where Conventional Loan Is Only Option

There are cases where a home buyer can only go with a conventional loan versus FHA loan.  For example, if you want to purchase a condominium that is not FHA approved, you need to go with a conventional loan versus FHA loan.  FHA insured mortgage loans are not allowed on non FHA approved condominium complexes.  For those who are buying foreclosures and/or REO’s and the home cannot pass FHA appraisal, the home buyer needs to go with a conventional loan versus FHA loan.  For home buyers buying second homes, vacation homes, or investment homes, they need to go with a conventional loan versus FHA loan.  FHA loans are only for owner occupant home buyers and first time home buyers and second homes, vacation homes, and investment homes do not qualify under FHA mortgage lending guidelines.

Loan Limits On Conventional Versus FHA Loan

The Federal Housing Administration has lowered its mortgage loan limits this year from $410,000 to $271,000 for most counties in the United States with the exception of high cost areas.  Conventional loan limits remain the same at $417,000.  The lowered FHA loan cap creates a problem for those homeowners who need to go with a FHA loan due to poor credit scores or those who had a prior bankruptcy, foreclosure, deed in lieu of foreclosure, or short sale.  One recent case study is where a mortgage loan borrower of mine was interested in purchasing a home in Pasco County, Florida.  The home was listed for $329,000 and my client has enough funds for the down payment.  The problem with this case study is that the borrower can only qualify for a FHA loan because her credit scores are below 620 FICO.  Unfortunately, due to the lowered limits of FHA loans, the maximum loan amount she can qualify is $271,000.  My client’s credit scores were over 620 FICO, however, she has three credit disputes she needed to retract.

Credit Disputes During Mortgage Process

You cannot have a credit dispute against a derogatory credit line item that has a credit balance during the mortgage approval process.  Retracting those credit disputes has lowered her credit scores to 597 FICO.  On this case study, my borrower either needs to come up with the difference between the purchase price of $329,000 and the maximum loan amount of $271,000 as additional down payment or wait until she can raise her credit scores to over 620 FICO so she can qualify for a conventional mortgage loan where she can qualify with putting 5% down payment or find a different home.

By Gustan Cho

www.gustancho.com

The information contained on Gustan Cho Associates website is for informational purposes only and is not an advertisement for products offered by The Gustan Cho Team @ Gustan Cho Associates or its affiliates. The views and opinions expressed herein are those of the author and/or guest writers of Gustan Cho Associates Mortgage & Real Estate Information Resource Center website and do not reflect the policy of Gustan Cho Associates Lenders Network, its officers, subsidiaries, parent, or affiliates.

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