For many people owning a home is their greatest asset. It’s important to understand the mortgage loan process if owning a home is your goal. There’s a lot of information to digest during the financing process but the basic information starts with the type of mortgage loan – Conventional or FHA.
It may not always seem clear whether to apply for a FHA loan or Conventional loan. The features of each mortgage loan may have an impact on your interest rate, the amount of your monthly payment and your overall cost of borrowing.
With conventional loans consumers must have good credit histories and a down payment of at least 20% to avoid paying private mortgage insurance (PMI).
On the other hand there are FHA loans which don't require good credit histories or such a large down payment. FHA loans are available to everyone, not just first-time home buyers. If you’ve purchased a home before, you may qualify for FHA.
Here are 5 reasons to get an FHA loan
1. Good credit is not required. The major advantage to selecting an FHA loan is easier credit requirements. Lower credit scores are allowed, in fact credit scores can go as low as 500 although individual FHA lenders can set higher guidelines of at least 580.
2. Low down payment required. FHA requires a lower down payment amount. With as little as 3.5 percent down, you can obtain a mortgage through FHA. Borrowers can use gift money for the down payment.
3. Major credit problems okay. Following a major credit issue like bankruptcy or foreclosure, consumers don't have to wait as long to obtain a mortgage loan through FHA. For instance, the bankruptcy timeframe is 2 years and if you’ve had a foreclosure due to loss of income the timeframe is 1 year.
4. Higher debt allowed. FHA loans are not limited to 36 percent for debt-to-income ratio like conventional loans. Debt-to-income (DTI) ratios measures a consumer's ability to pay off a mortgage loan or other debt. Lenders consider debt-to-income ratios to be as important, if no more, than credit scores.
One considers mortgage debt relative to income. The other looks at how much overall debt–mortgage, credit card, auto and student loan debt–a consumer has compared to his income. The higher a person's debt-to-income ratios, the bigger credit risk lenders consider them.
FHA’s debt-to-income ratios are more generous, at 43 percent, than the ones set by underwriters for conventional mortgage loans. In fact, under certain circumstances, FHA can go as high as 45% DTI.
5. Non-occupant co-borrower (relative) may be used for qualifying. FHA allows a co-applicant to help you qualify even if the person doesn't live in the home. A co-borrower can help make up for a poor or limited credit history (not due to a BK or foreclosure), heavy debt or limited savings.
FHA Fannie Mae HomeReady Program allows lenders to include income from non-borrowers within a household, such as extended family members, toward qualifying for a mortgage loan. The HomeReady program opens mortgage access to a segment of the population that doesn’t fit the typical family structure.
Who qualifies for an FHA loan?
Homebuyers with at least 3.5% of the purchase price of a property will also need to:
- Provide a valid Social Security number.
- Proof of U.S. citizenship, evidence of legal permanent residency or eligibility to work in the U.S.
- Be of age to sign a mortgage contract under your state’s borrowing laws.
- Purchase a one- to four-unit property.
- Find a list of FHA approved lenders at: HUD Lender List.
Drawbacks of FHA mortgage loans
There are a few drawbacks to FHA loans — the main one being high mortgage insurance fees. The upfront and monthly mortgage insurance premiums are some of the highest of any loan type and mortgage insurance remains for the life of the loan in most cases. FHA annual mortgage premiums are paid in 12 monthly installments every year, and are paid on top of principal, interest and insurance. For new FHA loans, they last for the entire life of the loan, regardless of whether you have more than 20 percent equity in your home.
Currently the mortgage insurance premiums range from 1.35 percent to 0.75 percent for loans with less than 5 percent down, and from 1.30 percent to 0.8 percent for loans with more than 5 percent down. But there is way out. Once you establish a good credit history and build up 20% equity in your home, you can refinance into a conventional loan in order to cancel mortgage insurance.