An FHA loan is a government-backed mortgage insured by the Federal Housing Administration. FHA loans are appealing to many borrowers because they offer attractive interest rates with more relaxed guidelines.
FHA Loan Requirements
Credit Score: FHA loans are a great option for those with less than stellar credit. The down payment required or in the case of a refinance, the Loan to Value (LTV), is contingent upon the credit score of the borrower.
- Scores between 500-579 allow a maximum LTV of 90%.
- A 580 score and above can go as high as a 96.5% LTV.
- The property must be owner-occupied.
- Available on 1 to 4 unit properties
Scores below 500 do not qualify for an FHA loan but there can be circumstances where a borrower with no score can get financing if they have a “nontraditional” credit history or insufficient credit.
It is important to remember that because an FHA loan is a government loan the borrower cannot be delinquent on any federal debts including but not limited to: government-issued student loans, prior FHA, VA or USDA loans, etc.
FHA Closing Costs
Gifts towards down payment and closing costs are allowed and the source can be any of the following:
- A Family Member;
- An employer or labor union;
- A close friend with a clearly defined and documented interest in the Borrower;
- A charitable organization;
- A governmental agency or public entity that has a program providing homeownership assistance to: low or moderate-income families; or first-time homebuyers.
What is Conventional?
A conventional loan is a loan that is not backed by a government entity, such as FHA, and follows the guidelines outlined by Fannie Mae and Freddie Mac. Conventional loans offer a great product for first time home buyers who have decent credit and money to contribute towards a down payment.
Conventional Loan Requirements
- Requires a credit score of at least 620.
- Does not need to be owner occupied-at a reduced LTV
- Conventional 97 program allows min down payment of 3% otherwise the standard down payment must be at least 5%.
Conventional Closing Costs
Conventional down payment and closing cost contributions by the borrower differ slightly from FHA in that the allowable gifts depend on the LTV and the type of property, as the table below shows. If part of the down payment or closing costs is being gifted, those funds must be seasoned in the gift donor’s bank account and verified with one month’s bank statement.
|LTV, CLTV, or HCLTV Ratio||Minimum Borrower Contribution Requirement from Borrower’s Own Funds|
|80% or less||One- to four-unit principal residenceSecond home||A minimum borrower contribution from the borrower’s own funds is not required. All funds needed to complete the transaction can come from a gift.|
|Greater than 80%||One-unit principal residence||A minimum borrower contribution from the borrower’s own funds is not required. All funds needed to complete the transaction can come from a gift.|
|Two- to four-unit principal residenceSecond home||The borrower must make a 5% minimum borrower contribution from his or her own funds. 1 After the minimum borrower contribution has been met, gifts can be used to supplement the down payment, closing costs, and reserves.
See B5-6-03, HomeReady Mortgage Underwriting Methods and Requirements, for HomeReady mortgage minimum borrower contribution and down payment requirements.
Mortgage insurance is a way to offset some of the losses incurred by the lender in the case of borrower default. FHA and Conventional loans differ in the ways they issue mortgage insurance. FHA charges an Up-Front Mortgage Insurance Premium (UFMIP) as well as a Monthly Mortgage Insurance (MMI). Conventional loans have Private Mortgage Insurance (PMI), which can be paid monthly, up front in full, or a combination of both.
FHA UFMIP and MMI
The UFMIP for FHA loans is at 1.75%. This amount is rolled into the base loan amount which is the loan amount minus the down payment. The MMI for FHA loans is typically .85%; which can be lower in the case of a shorter amortization or lower loan to value. It is important to note that MMI is there for the life of the loan on FHA loans but not in the case of a conventional loan.
PMI is a little different than FHA mortgage Insurance because it is not there for the life of the loan. PMI can be requested to be removed when the borrower reaches 20% equity (80%LTV) in the property and must be removed once the borrower reaches 22% equity (78%LTV). The percentage of PMI paid, unlike FHA’s MMI, fluctuates depending on the credit score of the borrower.
It is important to note that although you may qualify for a conventional loan it is not always the best option for you. As the above examples show, an FHA borrower will be paying $141.67 in MMI while a conventional borrower with scores between 620-639 will be paying $310 monthly in PMI. Over a 30-year loan this difference can come out to over $60,000. Therefore, it is crucial to exercise all options when pursuing a mortgage.
The average American home buyer holds a mortgage for 5 years. After 5 years many choose to refinance or move to a new home. Given this info, it is common for conventional borrowers to not reach the 78% LTV to extinguish their PMI. Before deciding to go with a conventional mortgage it is important for the borrower to consider how long they are planning to be in this mortgage for. It does not make sense for a borrower to pay more in rate and insurance for a conventional mortgage when they may be moving or refinancing in 5 years. Examining all options when considering the right mortgage “fit” for you is certainly worth possibility of saving thousands of dollars. For more information check FHA handbook.