VA Streamline Refinance

FHA Loans Versus Conventional Loans

ByGustan Cho
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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.

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.

Relationship Of Non-Occupant Co-Borrowers To Main Borrowers

Another benefit of FHA Loans is HUD will allow and approve borrowers with little or no income. This holds true if the main borrower can have a qualified co-borrowers to be added to the FHA Loan.

  • Under HUD Guidelines, in order to qualify for FHA Home Mortgages with non-occupant co-borrowers with 3.5% down payment, non-occupant co-borrowers needs to be related to main borrower by law, blood, or marriage
  • If non-occupant co-borrowers are not related by law, blood, marriage, HUD requires 15% down payment versus 3.5% down payment

Fannie Mae and Freddie Mac does not have the relationship requirement.

Multiple Non-Occupant Co-Borrowers

The good news with this FHA rule is that more than one non-occupant co-borrower can get added to the main borrower with FHA Loans:

  • Fannie Mae and Freddie Mac also allow non-occupant co-borrowers to be added to conventional loans
  • However, both Fannie Mae and Freddie Mac will allow non-occupant co-borrowers to be added but debt to income ratio is capped at 50%

Unfortunately, not too many mortgage lenders are Freddie Mac approved and will only do Fannie Mae Conventional Loans.

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.

List Of Benefits Of FHA Loans Versus Conventional Loans

Major benefits of FHA Loans Versus Conventional Loans are the following:

  • HUD allows a maximum debt to income ratio of up to 46.9% front end and 56.9% on the back end debt to income ratios if the mortgage loan borrower has at least a 620 credit score to get an approve/eligible per automated underwriting system
  • Borrowers with credit scores of under 620, the debt to income ratio requirements gets reduced to 43% DTI. to get an approve/eligible per AUS on FHA Home Loans

The maximum debt to income ratio requirements on conventional loans is capped at 50% debt to income ratios.

Benefits Of FHA Loans Versus Conventional Loans With Low Credit Scores

FHA Loans have lower credit score standards and are more lenient on prior bad credit than Conventional Loan Programs.

  • Minimum credit scores to qualify for 3.5% down payment FHA home purchase loans are 580 credit scores
  • Minimum credit score requirements for conventional loans are 620
  • It is much easier to get and approve/eligible per Automated Underwriting System with FHA Loans than they are with Conventional Loans

FHA is much more flexible with prior bad credit, outstanding unpaid collection accounts, charge offs, late payments, prior bankruptcy, prior foreclosures, and credit tradelines.

Benefits Of FHA Loans Versus Conventional Loans After Bankruptcy And Foreclosure

FHA requires a shorter waiting period after bankruptcy, foreclosure, deed in lieu of foreclosure, and short sale to qualify for a home loan than Fannie Mae and Freddie Mac on conventional loans.

  • Waiting period is 2 years after bankruptcy discharge date to qualify for a FHA Loan
  • Waiting period after bankruptcy is 4 years to qualify for conventional loan after Chapter 7 Bankruptcy discharged date
  • FHA requires a mandatory waiting period of three years after the recorded date of a foreclosure and deed in lieu of foreclosure and the date of a short sale to qualify
  • Fannie Mae and Freddie Mac require a mandatory 4 year waiting period after the recorded date of a deed in lieu of foreclosure or the date of short sale to qualify for a conventional loan

There is a 7 year waiting period to qualify for a conventional loan after the recorded date of a foreclosure and/or sheriff’s sale.

Benefits Of FHA Loans Versus Conventional Loans On Manufactured Homes

Many home buyers prefer to purchase manufactured homes.

  • Many manufactured homes these days are extremely modern with all of the amenities a homeowner can want
  • Many times cost less than a custom built or stick home
  • FHA and VA will finance home loans on manufactured homes that pass a structural engineer’s inspection report
  • Manufactured homes needs to be permanently attached to a concrete foundation and cannot be mobile

Fannie Mae and Freddie Mac will not allow home financing on manufactured homes.

Benefits Of FHA Loans Versus Conventional Loans On 2 To 4 Unit Homes

Any homes that are between one to four units are classified as residential homes.

  • FHA will allow primary owner occupant home buyers to purchase a 2 to 4 unit property with a 3.5% down payment

However, Conventional Loans require 15% down payment for owner occupants to purchase any two to four unit homes.

Benefits Of FHA Loans Versus Conventional Loans With Mortgage Insurance

FHA Loans Versus Conventional Loans With Mortgage Insurance

Many home buyers do not realize this but a home buyer with credit scores of under 680 credit scores will benefit more with a FHA Loan than a Conventional Loan if they are planning on putting down 3% to 5% down payment on a conventional loan.

  • Conventional Loan programs are extremely sensitive to credit scores and loan to value
  • Any conventional loans with greater than 80% loan to value will require private mortgage insurance
  • The cost of private mortgage insurance is not like FHA Mortgage Insurance Premium
  • FHA annual mortgage insurance is fixed at 0.85% on FHA 30 year fixed rate mortgage loans

With private mortgage insurance companies, they will determine what the private mortgage insurance will be after the mortgage insurance company reviews borrower’s credit scores, loan to value, and property type.

Benefits Of FHA Loans Versus Conventional Loans With Sellers Concessions

Sellers Concessions towards a home buyer’s closing costs are what many home buyers get so they can have most or all of their closing costs covered. FHA allows up to 6% of sellers concessions by home sellers to be used for closing costs. Conventional Loans maximum sellers concessions permitted is 3% for owner occupant primary homes and second homes. 2% sellers concessions for investment properties.

What Does Sellers Concessions Be Used For

Home buyers can use sellers concessions to cover all closing costs such as the following:

  • loan origination fees, costs to buy points to buy down mortgage interest rates
  • title charges
  • inspection fees
  • pre-paids (funds that need to be held in escrow)
  • homeowners insurance
  • attorneys fees
  • any other third party charges and fees

Sellers concessions cannot be used for down payment and any sellers concessions overage needs to go back to the seller and a kick back from the home seller to the home buyer with sellers concessions overage is not allowed. However, if there are overages in sellers concessions, the mortgage lender can use it to buy down the mortgage interest rates so it does not go back to the home seller.

Private Mortgage Insurance Mortgage Guidelines

One major advantage of conventional versus FHA loans is if the home buyer has excellent credit and has at least 20% down payment to put down on their home purchase, no mortgage insurance is required:

  • However, most home buyers do not realize that the annual private mortgage insurance varies on conforming loans
  • PMI which is paid by borrowers on a conventional loans is calculated as part of the borrower’s monthly payment
  • PMI is higher than the annual FHA mortgage insurance premium for borrowers with credit scores under 680
  • FHA Loans have much lower interest rates than conventional loans

If borrowers were to combine the lower mortgage interest rate with a FHA loan and the lower annual mortgage insurance for under 680 score borrowers, the FHA borrower greatly benefits due to the lower PMI.

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