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Evaluating 3 Mortgage Types: Conventional, FHA and VA

By Malcolm Rivers

There are several financing options when considering purchasing a home and potential borrowers should always compare different lenders and the options and services they offer. What follows is an overview of three different types of mortgages and what they bring to the table. Keep in mind that much of what will affect you as a potential buyer will depend greatly on a variety of factors so always do your research and carefully weigh your options.

Conventional Mortgages

Conventional mortgages are loans adhering to guidelines set by Fannie Mae and Freddie Mac, two Government Sponsored Enterprises established to benefit the US housing market. For a mortgage to be conventional, it must meet the terms and conditions for funding established by these two companies. Between 35-50% of all mortgages are guaranteed or purchased by the two and are thus considered conventional. For borrowers seeking a conventional mortgage, there are guidelines regarding credit, income and minimum down payments. Most conventional loans require a down payment of roughly between 5% to 20%. A borrower seeking a conventional loan should have a credit score that is at the least 620 and anyone with a score beneath 740 is risking additional fees.

Conforming

Conventional loans which are conforming have upper limits, a recent example being $417,000 for a single family home but these loan limits depend to some degree on region. For example, Alaska's upper limit is $625,000. Nonconforming loans are above lending limits set by Fannie Mae and Freddie Mac and are known as jumbo loans.

Interest Rates

Conventional mortgages have both fixed and adjustable interest rates. A fixed rate mortgage charges a set amount throughout the life of the loan, though the portion of principal and interest may change from month to month, the net payment remains the same. The interest rate for an adjustable rate mortgage changes; beginning lower and rising throughout the life of the loan. Typical fixed interest rate loans have terms between 15 and 30 years and frequently the shorter the loan term, the lower the interest rate.

Conventional mortgages can be costly due to origination fees, mortgage insurance and appraisal fees. Many of these costs are required at the outset or will be rolled into the mortgage amount which may cause a higher interest rates. Many lenders require higher down payments for conventional loans as well; some as much as 20% down.

Borrowers Who Should Consider Conventional Mortgages

Conventional mortgages are ideal for borrowers with excellent credit who can afford more costly down payments, which build home equity more quickly, and those who would prefer to avoid the bureaucratic hurdles posed by FHA or VA mortgages.

Benefits of Conventional Loans

Some costs are much lower for conventional loans. Private mortgage insurance (PMI) on conventional loans is frequently a better arrangement than the insurance offered in FHA loans. Conventional loans also allow for cancellation for PMI once a mortgage balance decreases to certain levels and cancellation of PMI is possible, regardless of down payment, once a given loan balance reaches 80% of the value of the home.

FHA Mortgages

The FHA, or Federal Housing Authority, does not, in fact, lend money. It provides government backing in the event of a default on a mortgage provided by FHA approved lenders. Loans backed by the FHA can also be fixed or adjustable rate mortgages.

Borrowers Who Should Consider Conventional Mortgages

FHA loans are good for borrowers who have a history of credit concerns, moderate to low debt to income ratios and would have difficulty with higher down payments. FHA loans are also good for borrowers who've recently come out of bankruptcy or foreclosure because it's easier to obtain a FHA mortgage than one that doesn't have government backing. Those seeking FHA backed mortgages are allowed to have moderate to high debt-to-income ratios (DTI) though a higher DTI means higher amounts of income committed to mortgage payment and it is recommended that borrowers keep mortgage payments to less than 25% of a borrower's income. Good credit scores can influence the necessary DTI but the standard is 31% to 43%.

Benefits of FHA mortgages

FHA mortgages provide a number of benefits for many potential buyer profiles.FHA mortgages require only 3.5% down payment on the mortgage and have no mandatory minimum credit scores, as requirements are decided based on the lender. Another benefit of FHA backed mortgages is that lenders are much more willing to look at the borrower's overall financial and credit history rather using automated software only which might invalidate certain borrowers immediately based on credit scores alone. Additionally, FHA mortgages have no prepayment penalties; provisions of the loan which state that should you pay the loan off entirely before a certain point you may be required to pay a penalty, frequently expressed in a percentage of the outstanding balance at the time of prepayment. Another buyer can take over, or assume, a borrower's FHA loan if its assumable and pick up where the original borrower left off, allowing them to enjoy many of the benefits of FHA mortgages. FHA backed mortgages have fixed and adjustable-rate loans as options, due to the numerous lenders through which a borrower can obtain a FHA mortgage. Co-applicants for FHA mortgages are allowed to assist borrowers in qualifying for the loan, even if the co-applicant is not a resident of the home, though borrowers typically can only have one FHA mortgage at a time. Sellers in FHA mortgage transactions are allowed to contribute up to 6% of the loan amount toward costs for closing which can save the borrower money up front. There are no income limits on FHA backed loans so buyers with higher income levels can still qualify for FHA mortgages.

Possible Concerns with FHA Mortgages

FHA mortgages may not be the perfect fit for all potential borrowers, there are some considerations and concerns to address for those thinking of applying for one. The FHA may charge a mortgage insurance premium (MIP) at the outset, up to 3%, though the upper limit for first-time homebuyers is 2.75%. FHA borrowers pay annual mortgage insurance premiums that are higher than those for conventional mortgages, though this difference is at least partially offset by lower rates on FHA mortgages. However, FHA borrowers also have to carry mortgage insurance longer than conventional mortgage borrowers have to. Lenders may have more specific requirements than the FHA does generally so it may be worth trying several lenders for FHA loans before committing to one. There are limits on how much a FHA mortgage borrowers can obtain, relative to prices for homes in the area, HUD's website has more specifics based on a borrower's location .

VA Mortgages

VA mortgages are loans for which the Department of Veteran Affairs provides a guarantee that protects a lender, frequently a private bank or mortgage company, against financial loss if the borrower fails to repay the loan. In order to get that guarantee, borrowers must pay a non-refundable funding free, 0-3.3% at the outset, which enables the lender to provide benefits and options to the borrower which otherwise may not be available through other means of finance. These fees vary based, in part, on the amount of down payment on the mortgage. VA mortgages provide an option requiring no down payment from the borrower with an increase of the funding fee and if the borrower pays 5% or more in down payment, the fee is reduced. Like FHA mortgages, the maximum loan amounts vary based on the location of the borrower.

Benefits of VA Mortgages

As noted earlier, VA mortgages can give a variety of options to borrowers some of which other forms of finance can't. VA mortgage borrowers can potentially obtain 0% down payment, have access to fixed and adjustable rate loans and enjoy qualification guidelines which are more flexible than those used in other types of loans. Potential borrowers include qualified veterans, reservists, active duty personnel and eligible family members. Mortgages of this type also allow grants and gifts to be used in helping borrowers with closing costs. Given the lack of PMI, private mortgage insurance, more of the payments on the mortgage go directly toward qualifying for the loan amount, which can allow for larger loans with similar payments.

Considerations and Possible Concerns with VA Mortgages

The VA's Veteran Loan program has service term requirements with a minimum number of days of completed service to qualify as a borrower and the program can only be used for purchasing a primary residence. Also, while the VA does not have a credit score minimum for pre-qualification, many lenders require scores of 620 or above for potential borrowers. The maximum borrowing amount, much like other loan types, for the VA is location dependent. Veterans with dishonorable discharges are disqualified from the loan program, unless a successful appeal is made that changes the discharge's status. Additionally, medical and general discharges may prevent a veteran from being eligible. Surviving spouses of veterans must continue to make payments on a loan if the veteran in whose name the loan was taken out, passes away.

Borrowers Who Should Consider VA Mortgages

Veterans, active service members and family members who meet the qualifications should consider VA mortgages. Given the low down payments, the lack of private mortgage insurance and the variety of financing, interest and payment options, VA mortgages should be considered by any possible borrower for whom income or down payment funds are a concern.

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About The Author

In 2005, Malcolm attended Harvard University where he received his Bachelors of Arts...

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