This BLOG On FHA Loans Popular Versus Conventional Mortgages Was PUBLISHED On December 14th, 2019
FHA Loans are the most popular mortgage programs today due to the many benefits it offers.
- There are thousands of mortgage loan applicants with great credit scores
- But due to the strict mortgage guidelines on conventional loans set by Fannie Mae and Freddie Mac cannot qualify for a residential mortgage
- Some of the hurdles conventional loan applicants face are high debt to income ratios, prior bad credit, prior bankruptcies, prior foreclosures, needing non-occupant co-borrowers, and unsatisfied collection accounts
FHA loan programs offer lenient mortgage underwriting guidelines, 3.5% minimum down payment, low mortgage rates, generous sellers concessions (HUD allows up to 6% in sellers concessions whereas conventional loans cap sellers concession credits to 3%), and short waiting periods after a prior bankruptcy and/or short sale.
FHA Loans Popular Due To Lower Mortgage Rates
Mortgage rates on 30-year fixed rate FHA Loans are much lower than 30 year fixed rate conventional loans offered by Freddie Mac and/or Fannie Mae.
- FHA Loans are not for every home buyer or homeowners who are needing refinance with bad credit
- Mortgage loan applicants with great credit may get better loan terms and programs with an FHA loan
Down Payment Requirement For FHA Loans
The United States Department of Housing and Urban Development created the Federal Housing Administration back in 1934:
- The goal of HUD was to make and promote homeownership possible to all hardworking Americans in a down housing market after the Great Depression
FHA Loans still remain the most popular loan program today.
Creation Of The Federal Housing Administration And How FHA Loans Popular
The main mission of the newly created Federal Housing Administration was to make the dream of homeownership possible with the smallest amount of down payment.
- The minimum down payment required for a potential home buyer is 3.5% of the home’s purchase price
- There are two other mortgage loan programs that do not require a down payment, which are VA Loans and USDA Loans
With VA Loans, you need to be a Veteran of the United States Armed Services and need a Certificate of Eligibility.
USDA Mortgage Loans
With USDA Loans, there are restrictions with regards that the mortgage loan application cannot have a debt to income ratios exceeding 28% front end debt to income ratios and the back end debt to income ratios cannot exceed 41%.
- USDA Loans also have income requirements where the mortgage loan application for a USDA Loan is capped on the maximum household income they can make in order to qualify
- The income requirement varies depending on the state and county the property is located and the number of dependents the borrower has on their tax returns
- The spouse’s income who is not on the USDA loan will be taken into account with the USDA mortgage program
Many of those who are eligible for VA Loans and USDA Loans turn to FHA Loans due to the more lenient mortgage lending standards.
Role Of FHA And Why FHA Loans Popular
FHA does not fund mortgage loans.
- FHA only insures owner-occupant mortgage loans to private lenders who are HUD approved
- The Federal Housing Administration guarantees lenders against default from borrowers who have defaulted on their mortgage loans
- FHA has insured more than 34 million loans for lenders in the United States since 1934
- FHA is still going strong
- FHA is making homeownership possible to all working Americans
- The popular loan program offers second chances for potential homeowners who have had prior financial hardship such as bankruptcies, foreclosures, deed in lieu of foreclosures, and short sales
Approved lenders need to follow FHA’s mortgage guidelines in order for their mortgage loans to be insured against default.
Basics Of FHA Loan Programs
As discussed earlier, a home buyer can secure an FHA loan with a 3.5% down payment.
- There are disadvantages with FHA loan programs besides the many benefits FHA loan program offers
- FHA charges an upfront mortgage insurance premium for all FHA Loan Programs of 1.75% of the mortgage loan amount
- The upfront mortgage insurance premium is normally rolled into the loan balance and the home buyer does not need to come up with this money
- For example, if the mortgage amount is $100,000, FHA will add 1.75% or $1,750.00 to the $100,000.00 loan balance so the total balance will be $101,750.00 instead of the $100,000.00
- HUD also will require FHA mortgage insurance premium on the principal loan balance for the life of a 30 year fixed rate loan
- This cannot be canceled no matter how low the loan to value is
- The annual mortgage insurance premium on an FHA loan is 0.85% of the balance
- This is calculated by dividing the 0.85% of the loan balance by 12 monthly payments
- It is escrowed by the lender
- It is paid monthly along with the principal, interest, taxes, and homeowners insurance
- Annual mortgage insurance premium on FHA loans gets reduced to 0.45% of the loan balance for 15-year fixed rate loans if the borrower can put 10% down payment
15 year fixed rate borrowers can cancel their FHA annual mortgage insurance premium after 11 years if their loan to value is at 78% LTV or lower.
Are FHA Loans Assumable And Reason Why FHA Loans Popular
FHA loans are assumable. This feature is a great benefit for borrowers who secured a 3.25% FHA rate in early 2013. Today’s FHA rates are at 4.25%. As mortgage rates rise, this is a great selling feature to potential home buyers.
- FHA rates are less credit score sensitive like conventional loans
- You will get different mortgage rates depending on your credit scores
- With conventional loans, the lower your down payment is, the higher your mortgage rates will be due to the added risk factor to the lender
- With conventional mortgage programs, the lower your credit scores are, the higher the mortgage rates are
- For example, for a borrower with a 740 FICO credit score and a 25% down payment, the rate may be 4.125%
- However, if the borrower has only a 5% down payment and a credit score of 620 FICO, the rates will most likely be 5.625% plus the borrower may need to pay points
For those seeking a conventional loan in the near future, they really need to start looking at their credit scores and see ways of maximizing their credit scores.
2 To 4 Unit FHA Multi-Unit Mortgage Loans
One of the biggest benefits with FHA loans are those home buyers who are planning on purchasing a multi-unit 2 to 4 unit building.
- Any properties up to 4 units are considered a residential home and for those who will be an owner occupant in a 2 to 4 unit property can take the huge advantage FHA loans have to offer
- FHA allows only a 3.5% down payment on a 2 to 4 unit property purchase
- This holds true as long as the home buyer will be living in one of the units for at least 12 months
- With conventional loans, the minimum down payment required on a 2 to 4 unit owner occupant property is a minimum of 15% down payment
If the multi-unit property plays their cards right, they can have their mortgage payments paid for by tenants from the rental income.
Potential Rental Income
With regards to potential rental income, HUD will allow 85% of the potential rental income to be calculated in the borrower’s debt to income calculations and no landlord experience is required.
- With conventional programs, only 75% of the potential rental income is allowed by Fannie Mae and/or Freddie Mac
- Many lenders will have their own overlays where they will require 2-year landlord experience from the borrower in order to count potential rental income in the borrower’s debt to income calculations
Mortgage Rates On FHA Loans
Another major benefit with FHA Loans is mortgage rates are lower than conventional mortgages.
- FHA loan will not have a mortgage rate adjustment on loan to value
- The higher the loan to value on conventional loans, the higher the mortgage rates
- With conventional loans, the more units the building has, the higher the mortgage rate
- Plus reserves are required on multi-family homes
Reserve requirement are monthly principal, interest, taxes, and homeowners insurance payments. 3 to 6 months of reserves are required on 2 to 4 unit properties.
Other Benefits Of FHA LOANS POPULAR And Special FHA Loan Programs
FHA allows for home buyers who have high debt to income ratios due to little or no income to have non-occupant co-borrowers to qualify for the mortgage loan.
- Non-occupant co-borrowers need to be family members
- Non-occupant co-borrowers are on the mortgage note but not on the title
- FHA also allows for the home buyer to get 100% gift funds from family members for the down payment
FHA 203k Loans
FHA also offers the FHA 203k loan program which is an acquisition and construction loan, all in one shot.
- A home buyer can purchase a home that needs either minor or major repairs and FHA will fund both the acquisition loan and construction loan
- The after repair value appraisal will be used the borrower needs to pony up the 3.5% down payment of the after repair value appraisal
- There are two types of 203K loan mortgage programs
- There is the 203k loan streamline loan which the maximum construction loan limit is $35,000
- With the 203k Streamline loan, the homeowner cannot do any structural changes
- They can do window replacement, roofing, plumbing, kitchens, bathrooms, basement, plumbing, electrical, HVAC, and other non-structural repairs
- They cannot do room additions or add luxury features such as outdoor kitchens or swimming pools
- With the full 203k renovation mortgage loans, there is no dollar cap
- The homeowner can do basically everything except pools, and luxury amenities such as installing outdoor kitchens, or basketball courts, or tennis courts
Room additions are allowed and structural changes are allowed but permits are required and the general contractor needs to have an arms-length relationship with the homeowner.
FHA BACK TO WORK EXTENUATING CIRCUMSTANCES DUE TO AN ECONOMIC EVENT
For first time home buyers or seasoned home buyers who had a prior bankruptcy, foreclosure, deed in lieu of foreclosure, or short sale, there are mandatory waiting requirements for both FHA loan programs and other mortgage loan programs. The traditional waiting period after a bankruptcy is that the mortgage loan applicant has a mandatory 2 year waiting period after the discharge date of bankruptcy. There is a three year waiting period for home buyers who had a foreclosure and/or deed in lieu of foreclosure from the date of the sheriff’s sale or the date the deed of the home was transferred out of the homeowners’ name into the name of the mortgage lender. There is a three year waiting period for those who had a prior short sale and the three-year clock starts from the date that the sale occurred per the HUD’s settlement statement.
Back in August 15, 2013, the United States Department of Housing and Urban Development, HUD, which is the mother of the Federal Housing Administration, has launched the FHA BACK TO WORK EXTENUATING CIRCUMSTANCES DUE TO AN ECONOMIC EVENT which waives the traditional waiting period of 2 years for a prior bankruptcy and the mandatory 3 year waiting period after a foreclosure, deed in lieu of foreclosure, and short sale. The FHA BACK TO WORK EXTENUATING CIRCUMSTANCES DUE TO AN ECONOMIC EVENT shortens the waiting period to one year after a bankruptcy, foreclosure, deed in lieu of foreclosure, and short sale. However, there are strict mortgage lending guidelines to qualify. The home buyer needs to have been either terminated from their prior employer or the employer needed to have been shut down and/or went out of business. Voluntary resignation or quitting their jobs due to rumors of potential layoffs does not count. The mortgage loan borrower needs to provide proof that they were out of work due to involuntary termination and due to this termination and the loss of at least 20% of their household income, they had no choice but to either file bankruptcy or had to foreclose on their home. They need to have been out of work for a minimum of six months in order to qualify.
The FHA BACK TO WORK EXTENUATING CIRCUMSTANCES DUE TO AN ECONOMIC EVENT mortgage loan applicant needs to have had great credit and a timely payment history prior to their loss of job and when the economic event happened, their credit scores have plunged. The applicant needs to have re-established credit and no late payment history after they have obtained a new job and currently be employed full time with a solid outlook that they will remain employed for the next three years. The FHA BACK TO WORK EXTENUATING CIRCUMSTANCES DUE TO AN ECONOMIC EVENT mortgage loan applicant needs to have a certificate of completion signed and dated by a HUD-approved housing counselor and need to wait 30 days from the date of the completion certificate in order to formally apply for the FHA BACK TO WORK mortgage loan. All FHA BACK TO WORK EXTENUATING CIRCUMSTANCES DUE TO AN ECONOMIC EVENT mortgage loans are all manual underwrites and compensating factors will greatly improve the chances of a mortgage applicant’s approval.
The FHA Back To Work Mortgage Program has been discontinued. Gustan Cho Associates now offers Non-QM Loans where there are no waiting period requirements after bankruptcy, foreclosure, deed in lieu of foreclosure, short sale.
December 14, 2019 - 8 min read