california refinance

california refinance

FHA Vs Conventional Mortgage Loans

 People looking for a home are offered two options in the mortgage market. They can either choose a conventional loan such as loans falling under Fannie Mae and Freddie Mac limits or a government insured loans known as FHA loans.

FHA or Federal Housing Administration

Federal housing administration serves as an umbrella for low and moderate income people who are not eligible for conventional mortgage loans. Not meeting the conventional mortgage loan criteria can be due to bankruptcy, bad credit, no credit or not having enough money for the down payments and other fees because of recent marriage or graduation.

 FHA operates on self generated budget and not on taxes given by people. FHA provides mortgage insurance on loans and the proceeds paid by homebuyers are used to operate this program. This insurance provides protection against losses incurred by the lender because of a defaulting home buyer. The government pays for these damages and this is what makes it easier for mortgage lenders to provide poor and moderate people a home loan.

 Types of FHA mortgages

 1. FHA 203(b) fixed-rate mortgage (15- or 30-year loans)

 This type of FHA loan has the minimum down payment about 3% of the total cost. It has a fixed interest rate which means you can get a financing up to 97% and minimum closing costs. This loan is the only home loan in which the entire 100 percent of closing costs or down payment can come from a non profit or government agency and relatives.

2. FHA 251 adjustable-rate mortgage

This type of FHA mortgage keeps the initial interest rate low and allows home buyers to qualify for a house they need. This program has several benefits. First they keep your monthly payments low and secondly the interest rate change is monitored. In a year the interest rate is not allowed to be increased by 1 percentage point and the change in rate over the life of loan cannot increase more then 5 percent.

 Conventional Mortgage Loans

 Conventional Mortgage loans are different than the FHA loans. These loans are not insured by the government and use the real estate that you buy as collateral (security) for the loan. In case you default the lender can sell the house for the repayment. Conventional loans fall under FNMA and FHLMC lending limits. Many of these loans require a huge down payment.

 Fixed rate mortgage

 This type of conventional loan is the most widely taken choice but it is very difficult for low and moderate income families to get these loans. Why? Because a fixed conventional mortgage for 15-30 year requires 20% deposit. The advantage of fixed loan is that you can keep track of your finances and have to pay a fixed amount each month with no change in interest rate over the life of the loan.

 Adjustable Rate Mortgages (ARM)

 Adjustable mortgages have a variable interest rate which increase or decrease according to the interest rate offered by Prime bank. In a typical adjustable mortgage, the interest rates are fixed for the first year or first few years and then they are adjusted by the lender. This is a good option if you want to get lower interest rates.

 Other Types of conventional mortgage

 Several other conventional mortgages exist in the market which include balloon mortgage, biweekly mortgages, bridge loans, construction mortgages, home equity line of credit, interest only mortgages, jumbo mortgages, refinancing, second mortgages, veteran’s administration mortgages and 125% mortgages

Prepayment Penalty

Conventional mortgages may also have a prepayment penalty which means you will have to pay a fee if you want to pay the remaining debt before the loan term is over. Watch out for this fee because it can .

 How Much FHA or conventional Loan You can Afford

 Most people want to have house that they like but dreams cost much more than what people can afford. FHA and conventional mortgages requires a person to qualify according to some set standards of debt to income ratio so that they get an affordable loan. Two types of ratios are used.

 One is “mortgage payment expense to effective income” in which total mortgage payment (mortgage principal and interest, property taxes, and insurance) is divided by your gross monthly income. This ratio should be 29% for FHA and 33% for a conventional loan. The second type of ratio is “total fixed payment to effective income” in which total mortgage payments and other revolving debts (student loans, car loans) are added up and divided by the gross monthly income. This ratio has to be 41% for FAH and 36% for conventional loans before you can qualify.

FHA vs. Conventional Loan           

FHA home loans and conventional home loans have several differences amongst them. First of all the down payment in FHA loans is very low i.e. 3% where as in conventional loans it can range from 5-20 % of the total loan cost. The FHA closing costs are controlled which means minimum fees are charged from you whereas in conventional loans you can be charged with loads of fees. The origination fee in FHA loans is maximum 1% whereas in conventional loans there is no limit on this fee.

Due to relaxed terms the qualifying ratio is higher for FHA loans in contrast to conventional loans. In FHA loans the seller can also credit 6% towards buyer closing cost whereas as in conventional loans the maximum credit towards closing costs of buyer is only 3%. The property you are trying to buy must meet the standard conditions provided by FHA before it can be bought where as with a conventional loan you can buy any type of real estate.

There is a 0.5 % mortgage insurance premium charged annually on FHA loan which is a small disadvantage but it is still lower than the percentage charged (0.55 to 0.98%) on conventional loans with a small down payments. The limit of mortgage loan provided by FHA is lower than the conventional financing.  

 Qualification GUIDELINES for FHA and conventional loans

The qualifying conditions for FHA are rather lenient unlike conventional loans. Although FHA loans don’t require a minimum income or excellent fico score but to qualify for FHA loans you still have to fulfill certain conditions.

  • Your mortgage payments have to be 29% of the gross income.
  • The bankruptcy should be 2 years old
  • Foreclosure should be 2-3  years old
  • You should have a steady employment
  • You should be using 2 lines of credit
  • Pattern of payments should be positive which means most of the payments should be on time with the exception of few late ones.
  • Applicants with delinquent federal debts, student loan and tax liens are not eligible.

Conventional mortgage loans require an applicant to have good credit, sufficient income, a handsome down payment, stable job and lower debt to income ratio. People with bad credit and bankruptcy can qualify for a conventional loan with some extra effort but the interest rates charged from these people are very high.

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