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Difference Between Conventional Versus FHA Loans

Difference Between Conventional Versus FHA Loans

This BLOG On Difference Between Conventional Versus FHA Loans Was UPDATED On January 29th, 2019

FHA Loans are the most popular mortgage loan program in the U.S.

  • HUD, the parent of FHA, is the government agency that sets FHA Guidelines
  • FHA is not a mortgage lender
  • FHA guarantees private lenders that originate and fund FHA Loans in the event borrower defaults and the property goes into foreclosure
  • FHA will insure the defaulted FHA Loans
  • There is no government guarantee with Conventional Loans
  • Conventional Loans are also called conforming loans
  • This is because they need to conform to Fannie Mae and Freddie Mac Mortgage Guideline

Cases Where Borrowers Can Qualify For Conventional But Not FHA Loans

Many borrowers ask the question of the Difference Between Conventional Versus FHA Loans.

  • There are many Difference Between Conventional Versus FHA Loans
  • There are times when home buyers may qualify for conventional loans but not FHA Loans and vice versa
  • Example on case scenario where home buyers qualify for conventional loans but not FHA Loans is cases where homeowners had mortgage part of Chapter 7 Bankruptcy
  • Waiting period Difference Between Conventional Versus FHA Loans on cases when mortgage was part of Chapter 7 Bankruptcy

Mortgage Part Of Chapter 7 Bankruptcy

Conventional Home Loans are generally for better credit and income profile borrowers. However, there are cases where borrowers will not qualify for FHA Loans but will qualify for Conventional Loans.

When a prior homeowner had a mortgage part of Chapter 7 Bankruptcy, Difference Between Conventional Versus FHA Loans is the waiting period:

  • On Conventional Guidelines On Mortgage Part Of Bankruptcy, there is a four year waiting period from the discharged date of Chapter 7 if there was a mortgage part of Chapter 7
  • Cannot reaffirm the mortgage
  • Housing event needs to have been finalized
  • There is no waiting period on housing event, whether it was foreclosure, deed in lieu, short sale, but needs to have been completed
  • With FHA Loans, the waiting period is three years from the date of the finalized housing event (foreclosure, deed in lieu, short sale)
  • Even though the mortgage was included in the Chapter 7, the waiting period start date is the recorded date of the foreclosure, deed in lieu, or the short sale date

Case Scenario Of Vanilla Conventional Loan Borrower

Here is an ideal conventional borrower

  • Say Borrower Smith have credit scores of over 740 and no history of bad credit
  • Also had no prior bankruptcies, foreclosures, deed in lieu of foreclosures, or short sale.
  • Have been perfect with paying bills and have never had a late payment in life
  • Have over 5 credit tradelines that are seasoned for over 24 months and a stable job for the past three years
  • Is a first time home buyer and want to purchase a home via the conventional loan route
  • Has 3% down payment to qualify for first time home buyer conventional loan program
  • Debt to income ratio is 45%

The above client is a perfect conventional borrower.

Benefits Of FHA Loans

The above case scenario is a case where the mortgage loan borrower seems like a solid borrower and seems like they can qualify for a conventional mortgage.

  • However, there are cases where a borrower who qualifies for a conventional mortgage need to move to FHA loan program due to many reasons
  • We gave an example above when some borrowers qualify for conventional loans and not FHA Loans

Reasons Why Solid Borrowers Need To Move Their Conventional Loan To FHA Loan Program

One of the biggest disadvantage of going with a FHA insured mortgage loan is due to the mortgage insurance premium.

  • FHA borrowers need to pay an upfront 1.75% mortgage insurance premium
  • Plus they get charged a 0.85% mortgage insurance premium on the balance of their mortgage loan for the life of a 30 year fixed rate FHA Loan
  • The only way to eliminate the mortgage insurance premium is to pay off the loan either by refinancing it to a conventional mortgage loan program
  • Or paying of the FHA insured mortgage loan by selling the home
  • FHA insured mortgage rates are lower than conventional loan mortgage rates
  • But due to the hefty mortgage insurance premium, the monthly housing expenses are normally higher
  • Good credit borrowers prefer going with conventional loan programs than FHA loans

Why FHA Loan?

However, there are cases where the conventional mortgage loan borrower needs to convert their conventional loan to FHA loan program.

Here are some examples where a borrower needs to convert the conventional loan to FHA loan program.

  • High debt to income ratios:  
    • A Borrower can have the best credit in the world but with high debt to income ratios, they will not qualify for a conventional mortgage loan
    • Conventional mortgage loan programs normally require 50% debt to income ratios
    • Exceeding those debt to income ratio caps will need to go from conventional loan to FHA loan
    • FHA debt to ratios can max out at 46.9/56.9% to get AUS Approval
    • 46.9% front end and 56.9% back end debt to income ratios
  • Deferred student loans: 
    • The Federal Housing Administration no longer allows deferred student loans that have been deferred for 12 or more months not to be counted towards debt to income calculations
    • 1.0% of student loan balance is used as monthly debt or:
      • If borrower can contact student loan provider and get a fully amortized monthly payment over extended term (25 years) that figure will be used
      • That figure turns out to be 0.50% of student loan balance
  • FHA does not allow for Income Based Repayment on student loans
  • Conventional Loans allows Income Based Repayment on student loans
  • With FHA and conventional loans future monthly student loan payments are calculated as part of debt to income calculations
    • If future monthly student loan payment from student loan provider cannot be provided, lender will calculate 1% of total student balance amount as monthly student loan payment
  • Non-occupant co-borrower: 
    • Non-occupant co-borrower can be added on FHA and Conventional Loans due to high debt to income ratios
    • FHA allows non-occupant co-borrowers from family members, relatives, or persons related by law
    • If non-occupant co-borrowers are not related, then 25% down payment is required
    • Fannie Mae and Freddie Mac does allow non-occupant co-borrowers
  • Conventional loan programs:
    •  Non-occupant co-borrowers do not have to be related like FHA requires
    • Fannie Mae and Freddie Mac allows non-occupant co-borrowers who are NOT family members to be added to borrowers

Difference Between Conventional Versus FHA Loans With Down Payment Requirements

  • Down payment: 
    • FHA allows 100% gifted funds for down payment
    • Conventional mortgage loan programs require that part of the down payment needs to come from borrower
    • Portion of it can be gifted
    • For example, the minimum down payment for a conventional loan is 5%
    • The mortgage lender will require 3% of the 5% required to come from the borrower and the other 2% to be gifted
    • FHA allows 100% of the down payment to be gifted
  • Multi unit properties: 
    • Buyers purchasing a 2 unit to 4 unit residential multi family unit, conventional mortgage loans require 15% down payment
    • However, FHA only allows 3.5% down payment on 2 to 4 unit multi family residential properties
    • This holds true as long as one of the units is the owner occupant unit

Home Buyers needing to qualify for mortgage with a direct lender with no overlays on government and conventional loans, please 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. We are available 7 days a week to answer any questions or mortgage scenarios.

By Gustan Cho

www.gustancho.com

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