|image by Wikipedia|
Although an FHA loan may cost more up front, if the buyer has a sketchy credit history, or a high debt to income ratio, an FHA loan may be their only option. It is important for buyers to understand the FHA does not actually write loans, but only guarantees them. This gives lenders the security they need to loan money to people who may not qualify for a conventional loan.
The first step in understanding FHA and conventional loans is to know the different types of loans offered by lenders. There are five major loan classifications used today.
- Conforming standard loans are eligible for purchase by Fannie Mae and Freddie Mac up to$417,000.
- Conforming jumbo loans up to$729,000 (depending on the county) are eligible for purchase by Fannie Mae and Freddie Mac.
- Non-conforming jumbo loans are not eligible for purchase by Fannie Mae and Freddie Mac and go beyond the $729,000 limit.
- FHA standard loans are eligible for FHA insurance up to $217,050.
- FHA jumbo loans up to $729,750 (depending on the county) are eligible for FHA guarantee.
FHA loans can also be broken down into three classifications.
- FHA 203(b) fixed-rate mortgage of 15 or 30 years
- FHA 251 adjustable-rate mortgage
- FHA 2-1 buy-down loans (This type of loan permits buyers to buy down a lower interest rate for two years for a fee.)
Which loan a home buyers opts for will depend on how much they have for a down payment, the interest rate they can afford, how long the loan needs to be, and their credit score. In the Boston area the median home price is $553,000. In order to qualify for a conforming standard loan, home buyers must come up with down payment of $116,000 compared with a down payment of over $300,000 to qualify for an FHA standard loan.
Another consideration is mortgage insurance.
With a 15 or 30 year FHA loan the borrower must pay 1.5 percent of the loan amount at the day of closing. This means for a$400,000 FHA jumbo loan the borrower must come up with $6,000. A0.5 percent renewal premium is also required for an FHA loan. This can add another $2,000 to each year of the loan’s lifetime. Most conventional loans do require mortgage insurance, but permit part of the fee to be added onto the loan amount. Once the home’s equity target level is reached, conventional lenders will issue (upon re-appraisal) the homeowner a partial refund or allow the mortgage insurance to be canceled.
If a homeowner has a low credit score and is unable to come up with a large down payment, an FHA loan is a good choice. For buyers with good credit, a conventional loan may be the better deal. Home buyers should ask about the best interest rates and terms for their home loans. By examining all of the options open to them, they can make the best choice based on their circumstances.