In today’s market, buying makes sense from a borrowing standpoint, as the cost of money is extremely cheap. A strong borrower can get an interest rate of under 3%. With this in mind, how can a potential buyer know if they are a strong borrower? And what options are available to them when applying for a mortgage? The two leading options for a mortgage are FHA and conventional loans. When deciding between these two loans, there are several factors that you and your lender will need to consider to determine if you will qualify for a loan and how much you can be approved to purchase. These factors will include: income, credit score, debt-to-income ratio, and the money you have available for a down payment.
FHA Loans
There’s a common misconception that FHA loans are exclusively for first-time home buyers. This is not true! The spirit of the FHA loan is to enable people to purchase a home when they wouldn’t traditionally (or conventionally) have the means to do so. If a borrower does not qualify for a conventional loan, that essentially means that the lender believes there is a higher probability that the borrower defaults on the loan. When a borrower defaults on a loan, this puts the lender’s investment in jeopardy.So, the FHA basically stepped in with the hope of providing less-fortunate individuals a chance at buying a home. FHA loans are insured by the Federal Housing Administration. This means if a borrower defaults on their FHA loan, the lender doesn’t have to worry about losing their investment. The FHA will actually step in and pay the remaining principal balance on the loan. So there’s less of a risk for the lender. Now, because the government is getting involved and putting federal funds on the line, they will not just lend to any individual that cannot qualify for a conventional loan. There are strict guidelines in place that the borrower and the property must meet to be approved.
For the borrower, this includes a minimum credit score of 580. A lower credit score would require a larger down payment. At least 3.5% of purchase price needs to be available for down payment; up to 10% if the borrower’s credit score is too low. A borrower’s debt-to-income ratio cannot be more than 50%. This would require that the borrower’s monthly debt does not exceed 50% of his/her monthly income. The property must meet very high standards for health and safety too. Don’t expect that house you like that needs a new roof to be approved for this loan. To determine if a property is up to par, an FHA required appraisal will be ordered to ensure that the property is safe and livable.
A big downside to the FHA loan is the mortgage insurance requirement. Typically, with any loan with less than 20% down, the borrower will be required to pay mortgage insurance. With conventional loans, when the borrower reaches 20% equity, he or she will no longer be required to pay the mortgage insurance. However, with FHA loans, so long as the buyer has a down payment of less than 10%, mortgage insurance will be required for the life of the loan. A simple fix for this would be to refinance the loan to a conventional loan once 20% equity is reached.
Conventional Loans
Conventional loans are typically a stronger option for borrowers that can afford a larger down payment and have better credit scores. As opposed to FHA loans, conventional loans are much more risky to a lender, which is why the lending criteria is more strict. If a borrower defaults on the loan, it’s not insured by the government. The lender will have to scramble to get their investment. If need be, they’ll take the short sale or foreclosure route. However, there’s always the risk that the home does not sell and the lender will be stuck with a property until a willing buyer comes along. Because of the high risk associated with a conventional loan, the requirements are more stringent. Typically a credit score of around 620 is required. A score north of 720 should yield better interest rates, however. Typical debt-to-income ratio should be 40% or lower going the conventional route. Down payment can range from a 3%-20% requirement, depending on the credit score, credit history, income, and debt-to-income ratio of the borrower. However, a larger down payment will mean lower monthly payments. Additionally, a down payment of 20% will not require mortgage insurance on the loan, whereas anything under 20% will until that 20% equity mark is reached. When the borrower hits that mark, no refinance is needed.
Conclusion
Overall, there are some great lending options for you out there. Conventional is for a stronger borrower and if it’s a really strong borrower, the loan will usually be less expensive than FHA. FHA creates opportunities for borrowers that may not have the available resources needed to take that leap towards buying a home. If you’re looking to purchase a home, contact us today and we’ll help you get in touch with the right lenders and more. Remember, Apex is always here to help you navigate your real estate journey in these uncertain times.
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