When wading through all types of loan products having a basic understanding is the beginning. The Real Estate and Mortgage industry is big on acronyms and jargon sometimes at their own peril, people making their living in Real Estate or lending are sometimes guilty of not clarifying loan products or terms only because they assume the borrower understands. My advice is to ask to a borrower is no question is stupid when ask with sincerity. An example of this simple confusion is the difference between FHA (Federal Housing Administration) and Conventional loans?
Even borrowers who have purchased previously may be confused or have been given incorrect information on loan products. Reference an informational article 2016 FHA Guidelines may also be some big help. There are three primary categories of financing they are either FHA, VA, or Conventional. There is also USDA but this is financing that is very limited and is to infuse money in an area to encourage development. For the purpose of this article and because USDA funding is limited we will unravel the confusion of the big three and they are as mentioned FHA, VA, or Conventional.
FHA was created in 1934. It sets standards for construction and underwriting and insures loan products made by banks and other private lenders for home building. The goals of this organization are to improve housing standards and conditions, provide an adequate home financing system through insurance of mortgage loans, and to stabilize the mortgage market. The FHA does not actually lend money to home buyers. It insures the loans that are given to qualified home buyers, through FHA- approved lenders. A lender will follow FHA guidelines to qualify a borrower for their loan product and when qualified if the loan has less than 20 % equity the borrower will pay in addition to the payment mortgage insurance that is insured through FHA protecting the lender in the event of default. We will revisit Mortgage insurance premiums in more detail shortly.
FHA assists Home buyers in a few critical areas of qualifying due to a less stringent lending standards than other types of loan products. FHA will qualify a borrow to be loaned money with a minimum of a 580 FICO score with a minimum of 3.5% down payment. A person can obtain financing with a FICO of 500-579 with a larger down payment of 10%. They also allow gift funds for the down payment up to 100%, but this needs to be documented properly. Although these are minimum guidelines most lenders have additional less lenient standards (referred to as overlays). For example most banks minimum FICO is 620, however I am associated with Gustan Cho Associates and we use minimum FHA standards to qualify with no overlays.
As mentioned earlier FHA guidelines allow a borrower to obtain an FHA loan product with a FICO score of 580 and only have to gather 3.5% down payment, this is substantially less than most conventional loans. For a borrower to close a new loan they must also be able to pay for closing costs and the funds to close must be verified prior to the signing (closing). However FHA allows seller concessions or seller contributions towards closing up to 6%. It is important not to waste or lose any of the 6% seller concessions, if there are any excess funds available after closing costs it cannot be credited or given back to the buyer. This would be considered a kickback and is not allowed, but any excess funds can be used toward the buying down the interest rate.
Credit score isn’t the only aspect of a borrower’s credit worthiness that s considered. FHA also looks at the buyer’s payment history referred to as common sense lending standards. Credit problems in the past, late payments or a non-medical consumer loan default doesn’t mean the application is dead, however FHA may recommend a Consumer Credit Counseling program to avoid being denied the loan. FHA loan products are the most popular choice of first time home buyers mainly because of the reasons mentioned above, beginning with the credit score. Additionally first-time home buyers often have no mortgage history that often help in building a higher credit score needed to qualify for a Conventional loan product. There is no impact on an FHA Loan interest rate due to a rough credit past or limited credit history either a person will meet the guideline or they do not but they are not penalized with a higher interest rate once they qualify.
Currently the real estate market is experiencing historically low interest rates but they are poised to go up as the economy recovers. Many people, most first-time home buyers are opting for FHA loans simply because of the lower down payment requirement and maybe because those funds can be gifted or maybe because they allow seller concessions up to 6%. Any way you look at it FHA loan products minimum guidelines allow for less upfront money than conventional financing for first time home buyers or young professionals just starting out. While interest rates are low it stands to reason this may be a great time to invest in home ownership as opposed to waiting for a 20% down payment often required for many conventional loans. How long would it take to save 20% down payment ? In the time it would take to save this amount of money interest rates would very likely rise and offset any gains against from a higher down payment or any MIP. Remember the greatest real estate appreciation normally occurs during lower interest rate eras.
FHA loan products require Mortgage Insurance to protect lenders in an unfortunate default. For any loan where the buyer owes more than 78 % of the home value, a Mortgage Insurance Premium will be added. Mortgage insurance was just lowered in 2015 from 1.35% of the premium amount to .85%, this represents a savings on the average loan of $900 per year or $75.00 a month. The Upfront Mortgage Insurance Premium (UPMIP) is currently at 1.75% of the base loan amount.
FHA loan limits, often differ based on local markets. In Maryland, Montgomery and Frederick Counties, the limits are $625,500 while in Osceola County, FL it can be $271,050 for a single dwelling. FHA loan limits can be viewed by clicking the hyperlink.
A VA Loan is a mortgage loan in the United States guaranteed by the U.S. Department of Veterans Affairs (VA). The VA loan may only be issued by qualified lenders. The VA Loan was designed to offer long-term financing to elgible American Veterans or their surviving spouses (provided they do not remarry). The basic intention of the VA direct home loan was to provide financing to eligible veterans in areas where private financing is not generally available and to help veterans purchase properties with no down payment. Here are some borrower benefits on a VA direct loan.
There are maximum loan limits typically $417,000 but it can be higher in certain high cost counties. In Hawaii and Alaska the limit is $625,500.
The VA Loans are made through private lenders and the loans are guaranteed through the Veterans Affairs but a borrower is not required to buy the Mortgage insurance. VA Loans are the ONLY loans today that offer no down payment, no MIP, often lower interest rate and will also allow financing up to 103.3% of the value of the home. A VA Loan does have a minimum credit score of 620 requirement through most lenders. VA and FHA have their own guidelines and some differences and current terms on FHA secured loans. We at Gustan Cho associates can guide you through these guidelines.
A Conventional loan program is not guaranteed by an government agency or insured by FHA or VA. A non Government sponsored loan (GSE), private conventional loans are secured by investors. Therefore, the qualification requirements are usually more stringent than FHA or VA Loans. One advantage to a conventional loan product is they are ideal for a vacation home or second home financing, where as FHA restrict their loan product for either type of residence. Some of the more common traits of conventional loan products are:
Loan-to-value (LTV) means how much a person is borrowing compared to the overall value of he home. The more money put down on a home purchase represents less risk to the lender due to the lower LTV. The less money put down on a home purchase increases the risk for the lender due to a higher LTV. More risk to the Lender will be more costly to the buyer in terms of a possible higher interest rate and the purchase of more PMI. If the LTV is less than 80% there will be PMI on a conventional loan. The PMI is a single premium, whereas with FHA there are both upfront and monthly premiums. The term of a loan can be 15, 20, 30 or even 40 years and with each there will be a different interest rate.
The Larry Stepp Team at Gustan Cho Associates are available 7 days a week, holidays and weekends.
Larry Stepp 407-922-4755 LarryS.HomesNetwork@gmail.com