Conventional Versus FHA Home Loans Mortgage Guidelines

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Conventional Versus FHA Home Loans Mortgage Guidelines

This BLOG On Conventional Versus FHA Home Loans Mortgage Guidelines Was UPDATED On February 5th, 2019

The Federal Housing Administration (FHA)  guarantees residential mortgage loans to HUD Approved lenders. FHA and Conventional Loans are the most popular mortgage loan programs in the United States. On this blog, we are going to compare Conventional versus FHA Home Loans:

  • FHA loans are an excellent mortgage loan program for first time home buyers
  • FHA Loans 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
  • HUD partially insures lenders in the event FHA borrowers default
  • HUD mortgage guidelines are much easier than conventional guidelines
  • There are much more advantages with FHA loan programs than there is with conventional loan programs for borrowers with bad credit and higher debt to income ratios
  • However there are cases where borrowers needs to go with a conventional versus FHA home loans
  • We will discuss later in this article

Basic FHA Lending Guidelines

HUD, the parent of The Federal Housing Administration created the FHA loan program to make home ownership possible to all hard working Americans.

  • FHA are extremely popular for first time home buyers and seasoned home buyers
  • FHA 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 mortgage with bad credit can qualify for a FHA loan with a credit score as low as 500
  • For home buyers who need a home loan with bad credit and who has credit scores between 500 and 579 credit scores can qualify for a FHA insured mortgage as long as they can put a 10% down payment
  • For those who can only put a 3.5% down payment, borrowers needs a credit score of at least a 580 credit score
  • Home buyers who need a home loan with bad credit, a FHA loan is the perfect 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:

  • Minimum credit score of 500
    • Home Buyers who need a home loan with bad credit and credit scores fall between 500 and 579 credit scores, FHA requires need a 10% down payment on home purchase
    • Debt to ratio caps are 31% front end debt to income ratio and 43% back end debt to income ratio to get Automated Underwriting System Approval (AUS)
  • To qualify for a 3.5% down payment FHA loan, Credit scores needs to be 580 minimum
    • Those with credit scores of under 620 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 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% to get AUS Approval
    • Non-occupant co-borrowers are allowed on FHA loans
    • The borrower does not to provide any income as long as he or she has a non-occupant co-borrower

Non-Occupant Co-Borrowers On Conventional Versus FHA Home Loans

To qualify for 3.5% down payment FHA Loans with non-occupant co-borrowers, non-occupant co-borrowers needs to be related to borrowers by law, marriage, or blood. If not related by law, blood, marriage, then the home buyer needs to put 25% down payment on FHA Loans.

  • 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
    • 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 recipient account needs to be sourced by providing bank account information by both the donor and recipient
    • Normally, mortgage lenders want to see a 30 day seasoning of the gift funds from the donor’s bank statement

Conventional Loans do not require non-occupant co-borrowers to be related to main borrower by blood, marriage, law. Friends, relatives, and others can be non-occupant co-borrowers.

Outstanding Collections And Charged Off Accounts

All loan programs does not require outstanding collections and charged off accounts to be paid to qualify. However, FHA has the most lenient standards when it comes to getting an approve/eligible per AUS on outstanding collections/charged off accounts.

  • Open collections and unsatisfied derogatory credit is allowed per HUD 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 borrowers 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 and/or bank statements

Conventional Versus FHA Home Loans With Bad Credit

  • 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: 
    • Borrowers with a prior Chapter 7 bankruptcy, the home buyer needs to meet two years waiting period after the discharged date to qualify for FHA Loans
    • 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 to qualify for FHA
    • 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 to qualify for FHA
    • Re-established credit and no late payments after the period of derogatory period has lapsed is mandatory

Income Based Repayment Mortgage Guidelines

HUD does not allow IBR Payments on FHA Loans. Borrowers with high student loan balances may need to opt to go with conventional loans. Conventional Loans allows income based repayment on student loans to be used for DTI Calculations. FHA requires 1.0% of the outstanding student loan balance to be used for DTI Calculations. Please contact us at Gustan Cho Associates at 262-716-8151 or text us for faster response to go over this. Or email us at gcho@loancabin.com.

Waiting Period After Bankruptcy And Housing Event

The disadvantage of having a conventional versus a FHA home loan is that conventional mortgage require longer waiting period after bankruptcy and/or housing event.

  • Housing events are the following:
    • foreclosure
    • deed in lieu of foreclosure
    • short sale

Conventional Loan Versus FHA loan On Waiting Period After Foreclosure

    • With conventional programs, the waiting period is 4 years from the date of the bankruptcy discharge to qualify
    • There is a seven year waiting period after recorded date of the foreclosure in order to qualify for a conventional mortgage loan
    • There is a four year waiting period after short sale or deed in lieu of foreclosure to qualify for conventional mortgages

Conventional Versus FHA Home Loans On Sellers Concessions

  • FHA and USDA 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
  • VA allows up to 4% sellers concessions

Mortgage Insurance On Conventional Versus FHA Home Loans

  • Mortgage insurance premium: 
    • A big disadvantage of not having a conventional versus FHA home loans is that 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 0.85% of the balance of the FHA loan
    • This is paid for the lifetime of the 30 year FHA insured mortgage loan
    • Borrowers cannot cancel this annual 0.85% 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
    • The advantage of conventional versus FHA home loans is that the annual private mortgage insurance premium is much less than those of FHA for borrowers with higher credit scores
    • Conventional loan private mortgage insurance premiums are about half of those of FHA mortgage insurance premium of 0.85% in instances where borrower credit scores are over 700

Conventional Versus FHA Home Loans On Multi-Unit Properties

  • 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
  • With conventional loans 15% down payment is required
  • FHA loans are for owner occupant home purchases only
  • Home Buyers who are interested in purchasing a second home, vacation home, or investment home need to go with conventional loans

Conventional Versus FHA Home Loans On Credit Score Requirements

Conventional requires higher credit scores than FHA.

  • First of all, to qualify for a conventional loan, borrowers needs a minimum credit score of 620
  • FHA mortgage rates are not credit sensitive
  • Anyone with a 640 or greater credit score will get the best FHA mortgage rates
  • However,  a difference between conventional versus FHA home loans is that with conventional loans, mortgage rates are credit score driven
  • The lower credit score, the higher mortgage rate will be
  • To get the best conventional mortgage rate, borrowers need to have credit scores of over 760
  • Every 20 point increments yields a higher mortgage rate

Loan Level Pricing Adjustments

The lower borrowers credit scores, the higher the mortgage rates on conforming loans:

  • The breakdown on mortgage rates are
    • 760
    • 740
    • 720
    • 700
    • 680
    • 660
    • 640
    • and 620

For those with credit scores of 620 can expect a high mortgage rate if they are seeking a conventional loans.

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.

  • Fannie Mae does not allow for non-owner occupant co-borrowers like FHA insured mortgage loans do
  • Freddie Mac does allow non-occupant co-borrower but many lenders are not Freddie Mac approved
  • Fannie Mae and Freddie Mac allows 3% down payment on conventional loans for first time home buyers
  • Both Fannie and Freddie define first time home buyers on those who did not have any ownership in any homes in past three years

Gift Funds

  • Another disadvantage on conventional versus FHA home loans 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 lenders want the home buyers to put some skin in the game
  • For example, a conventional lender may allow the home buyer to put down a 3% down payment and allow a 2% gift funds from a family member

Conventional Loan After Foreclosure

A disadvantage with conventional versus FHA home loans is that there is a mandatory 4 year waiting period after Chapter 7 Bankruptcy discharged date:

  • 7 years after foreclosure to qualify for a conventional mortgage
  • FHA mortgage programs have shorter waiting periods after a person has filed bankruptcy and/or foreclosure

Conventional Versus FHA Home Loans 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, borrowers need to go with a conventional versus FHA home loans
  • FHA 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 versus FHA home loans
  • 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
  • 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 $294,515 to $314,827 for most counties in the United States with the exception of high cost areas.

  • Conventional loan limits is $484,350
  • 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
  • Unfortunately, due to the loan limits of FHA loans, the maximum loan amount she can qualify is $314,827
  • My client’s credit scores were over 620
  • However, she has three credit disputes she needed to retract

Credit Disputes During Mortgage Process

Borrowers 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
  • 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 $314,827 as additional down payment or wait until she can raise her credit scores to over 620 so she can qualify for a conventional mortgage loan where she can qualify with putting 5% down payment or find a different home

Home Buyers who need to qualify for mortgage with a direct lender with no overlays on government and conventional loans can contact us at The Gustan Cho Team at Loan Cabin at 262-716-8151 or text us for faster response. Or email us at gcho@loancabin.com.

By Gustan Cho

www.gustancho.com

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