FHA vs. Conventional
You’ve made the initial steps to buy your first home. You’ve reached out to a lender for a pre-approval. You’ve received a pre-approval, but is it the best loan product for you? There are many different types of loans but for most consumers they’ll have to decide between a FHA and Conventional loan. So, what’s the difference?
FHA
An FHA loan is a mortgage issued by an FHA-approved lender and insured by the Federal Housing Administration (FHA). Designed for low-to-moderate-income borrowers, FHA loans require a lower minimum down payments and credit score than many conventional loans. Federal Housing Administration doesn't actually lend you money for a mortgage. Instead, you get a loan from an FHA-approved lender, like a bank, and the FHA guarantees the loan.
Down-payment is typically 3.5%. With FHA loans, your down payment can come from savings, a financial gift from a family member or a grant for down-payment assistance. FHA loans require mortgage insurance premium that you must pay for the life of the loan.
Credit
You'll need a credit score of at least 580 to qualify. If your credit score falls between 500 and 579, you can still get an FHA loan provided you can make a 10% down payment. Your interest rate is subject to your credit score rating.
Gifts
Buyers are able to receive up to 100% of the down-payment in the form of a gift. Typically it must come from a relative or spouse. Gifters often have to submit bank statements as well.
Student Loans & Ratios
FHA does not allow student loans in deferment to be excluded from your debt-to-income ratio. In fact, if the monthly payment on your credit report is less than 1% of the total balance of your student loan, the lender must increase the monthly payment to 1% of the balance and use that to qualify
FHA will allow your housing payment to be as high as 46.99% front-end Debt to Income, and a maximum 56.99% back-end Debt to Income including your debts.
Conventional
A conventional mortgage or conventional loan is any type of home buyer’s loan that is not offered or secured by a government entity. Instead, conventional mortgages are available through private lenders, such as banks, credit unions, and mortgage companies. However, some conventional mortgages can be guaranteed by two government-sponsored enterprises; the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac).
Down-payment There are various down-payment options. There is 100% financing where 3% is financed into the loan as a second mortgage, which typically carries a higher interest rate. Lenders offer 3% down, 5% down, 10% down, 20% down loans as well. When you put down less than 20% you’re required to pay private mortgage insurance (similar to mortgage insurance premium).
Credit
Conventional loan requirements vary lender to lender, but usually a minimum of 620 credit score is required. When you put down less than 20% you’re required to pay private mortgage insurance (similar to mortgage insurance premium). This can be paid up front or in the monthly mortgage payment. The big difference between Mortgage Insurance Premium (MIP) and Private Mortgage Insurance (PMI) is PMI goes away once the Loan to Value Ratio falls below 80%. Meaning if your home’s loan is below 80% of the home value, then PMI falls off of your monthly mortgage payment. Conventional loans only allow up to 3% of closing costs to be covered by seller.
Gifts If you're taking out a conventional loan – which means one that's backed by Fannie Mae or Freddie Mac – all of your down payment can be gifted if you're putting down 20% or more. If you're putting down less than that, part of the money can be a gift but some of it has to come out of your own pocket.
Student Loans & Ratios
Debt ratio generally must be 45% or below, although exceptions are allowed up to 50% if you have higher credit scores and extra cash on hand after you close.
There are different guidelines followed for conventional loans depending on whether the loan is backed by Freddie Mac or Fannie Mae.
For Freddie Mac, if there is a payment amount reporting on the credit report, lenders are permitted to use the amount shown for debt ratio calculations.
This applies to income-based repayment plans as long as they are reporting on the credit report or if they have documentation showing the homeowner is in an established repayment plan is allowed.
For student loans whose repayment period has not yet started due to the homeowner still being in school, or if the payment has been suspended for a period of time, documentation need to be obtained to verify the monthly payment amount included in the monthly debt ratio.
If no payment is being reported on the credit report on a student loan that is deferred or is in forbearance, one percent of the outstanding balance is used for calculating debt ratios.
For Fannie Mae, income based repayment plans are not acceptable.
For all student loans, which are deferred or in forbearance, or in repayment (not deferred), lenders must include a monthly payment as structured below:
One percent of the outstanding balance
The actual payment that will fully amortize the loan(s) as documented in the credit report
A calculated payment that will fully amortize based on the documented loan repayment terms, or
If the repayment terms are unknown, a calculated payment will fully amortize the loan(s) based on the current prevailing student loan interest rate, and meet certain criteria imposed by Fannie Mae’s guidelines.