If you are planning to buy a home, you should acquaint yourself with the different options of mortgage loans available.
To ease the burden of uncertainty, this article will walk you through two of the most popular home loans that you can apply for: FHA loans and conventional loans.
Buying a home is no easy feat because it is one that needs a hefty amount of cash.
So if you’re planning to purchase a home and you don’t have enough cash from your pocket, let alone your savings, a home loan is the best option as a financial source.
FHA Loan and Conventional Loans: The Most Common Types of Home Loans
There are many types of home loans available through bank financing and through private lenders. The FHA loan and the conventional loan are two of the most common types.
Choosing the right type of mortgage for you depends on how you can agree with the terms of the loan and your financial goals for a home loan.
FHA (Federal Housing Administration) Home Loans
FHA loans are insured by the government.
They are loans approved by the Federal Housing Administration for homebuyers who meet the criteria.
According to USBank, FHA loans are well-suited for first-time homebuyers, especially those who have low credit scores.
Because the government insures mortgages made by private lenders for single-family properties, if you default on your mortgage, FHA pays a claim to the lender for the principal balance that you were not able to pay.
This makes it easier for lenders to facilitate more mortgages because they take on less risk.
Qualifying for an FHA Loan
FHA loans are a favorite of home buyers because they are said to have looser requirements compared to other loan types.
Here are the standards you have to meet to qualify for an FHA loan:
- 2 years of steady employment in the same line of work
- A credit score of at least 620 (some lenders allow a credit score of 500 with other requirements)
- Available only for primary residence occupancy. You have to live in the property that you will be buying.
- A minimum down payment of 3.5% of the purchase price. If you will be paying a down payment through a gift fund, which is a monetary gift from a family member, friend, employer, charitable group, or a government homebuyer program, you will have to follow the process required so that the gift will be accepted as payment. You may be asked to secure a note stating that it is a gift and not a loan.This is a unique feature of the FHA loan — protecting an applicants’ ability to accept monetary gifts for payments to as much as 100% of the down payment.
- Front-end ratio (monthly housing expenses divided by your monthly gross income) should be below 31% but some lenders approve up to 47%.
- Back-end ratio or debt to income ratio should be less than 43%, but other lenders can be flexible with this as long as you meet certain requirements
- Payment of two kinds of mortgage insurance premiums:
- Upfront Mortgage Insurance Premium (MIP) of 1,75% of the home loan, regardless of your credit score. This can be paid a lump sum at closing or it can be rolled into the mortgage payments.
- Monthly MIP. This is included in your monthly mortgage payments and is based on your loan-to-value ratio, the size of your loan, and the term for your loan to be paid-off or the life of your loan.
- Secure and provide the necessary documents:
- Job records or employment certificates
- Income tax forms
- Addresses of the locations you’ve lived in the last two years
- Addresses and names of your employers for the last two years
- Statement of your gross monthly salary
- Valid W2 forms
- Property appraisal and inspection by an FHA-approved appraiser. Appraisals are done to ensure that the property complies with health and safety regulations and to determine the property’s value if it is similar to other homes in the area. Once your application for an FHA loan has been approved, you should prepare cash to complete the loan transaction. Closing a loan application will require payment of fees that are generally 3.5 to 4 percent of the purchase price of the property you will buy. Expect to be paying these miscellaneous fees and expenditures:
- Attorney’s fees
- Appraisal fee
- Title examination
- Prepaid interest
- Property taxes
- Recording fees
- Loan origination fee (1% or more of the value of the loan)
Conventional Home Loans
These loans are the most popular, representing over 75% of all home loans.
It is a mortgage where the interest rate remains the same throughout the entire life of the loan, according to Mortgage Calculator.
Conventional loans pose the most risk for lenders because this type of home loan is not backed by or insured by the government. This risk makes lenders approve applicants who have the strongest financial profiles.
A conventional mortgage is provided by private institutions and the insurance is covered by a third-party insurance company and is called a Private Mortgage Insurance (PMI).
Qualifying for a Conventional Loan
Conventional loans are common because they are known to be the least restrictive of all mortgage loans — they don’t demand special requirements from the borrower. The standard requirements for a conventional loan are:
- A credit score of at least 620 to 640, but preferably over 700 for lower interest rate
- A down payment for as low as 3%-5% of the purchase price
- PMI (Private Mortgage Insurance) pays monthly if your down payment is 3%, but is not required if you pay a 20% down.
- Debt-to-income ratio (DTI) that is no more than 43% and smaller than 36%
- Interest Rate that is dependent on your credit score and the movement of the stock market. The average conventional loan rate today, according to mortgage reports, is 2.875% for a 30-year, fixed-rate conventional loan. The fixed-rate mortgage feature is one of the biggest advantages of a conventional loan since you know exactly when the interest and principal payments will be for the length of the loan with an interest rate that will never change throughout the loan’s duration.
- Life of the Loan can be 10, 15, 20, or 30 years for fixed-rate mortgages.
- Documents to secure and submit include:
- State-issued IDs
- Income tax returns
- W2 statementsMos
- t recent pay stubs
- Most recent bank statements
- Other sources of income (retirement accounts, social security statements, alimony)
- Employment verification
- Closing Costs that cover fees like:
- Lender’s origination fee
- Vendor fee
- Appraisal fee
- Title insurance
- Credit reporting fees
Conventional Loan Requirements for 2020
After you have been acquainted with the outlined differences in the requirements and documents that you should meet and secure to qualify for an FHA loan and a conventional loan, you can better weigh which mortgage loan plan is most suitable in your current financial situation.
Both FHA and Conventional loans are offered by lenders in the private sector. The practical differences that are key distinctions between the two include how you can qualify for a loan and the down payments.
The FHA loan requires that you meet both the lender’s and the government’s criteria, while a conventional loan requires meeting the lender’s criteria alone.
Qualifying for an FHA loan is easier if you have a low credit score since the government insures your mortgage, but for a conventional loan, even if a lender approves your application with a low credit score, you will have to compensate by fulfilling other requirements like a bigger down payment and higher interest rate.
On a final note, as a home buyer, you should learn all the pros and cons associated with FHA and conventional loans.
Study the criteria for each loan and consider your financial status and financial goals. This will help you make a smarter decision on the best financing option for your dream home.