Three Types of Mortgages for Homebuyers

During the home financing process, you will find lenders may offer a variety of loan programs. The most common types of mortgage loans include FHA loans, conventional loans, and VA loans. These common loan types have different requirements for credit scores, down payment, loan limits, mortgage insurance, and debt-to-income ratios. If you’ve done your homework and have a general idea of the conditions for these loan types, you may assume that one type is better for you than another — but that may not necessarily be the case.

Here, we will outline the these types of mortgages and show you how they stack up against each other. We hope this information will be useful as you navigate the mortgage process and make it easier to find the loan that works best for you.

FHA Loans

Not everyone who wants to buy their first house has saved up a huge down payment or attained a high credit score. Because many people don’t qualify for conventional loans the first time around, the government has made it possible to own a home even with lower scores.

FHA loans financed and serviced by individual lenders but are insured by the US Federal Housing Administration, allowing those with credit as low as 500 to obtain a loan with a 10% down payment; those at 580 or higher can get a loan with 3.5% down. With these more flexible credit score requirements and down payment options, FHA loans require you to have mortgage insurance, no matter how large a down payment you provide. Keep in mind, this will affect your overall costs. And even though FHA establishes these thresholds of down payment requirements, not all lenders will provide FHA financing below certain credit score levels dependent on their own risk policies.

Pros:

• Lower down payment
• Works for low credit scores
• Higher DTI requirements
• No income limits
• Affordable mortgage insurance for low credit
• Shorter waiting periods after previous foreclosures or bankruptcies

Cons:

• Limited loan amounts
• Limited to primary residence
• Strict housing standards
• Added cost of mortgage insurance

Conventional Loans

Conventional loans, unlike FHA loans, are not insured by the government, so qualification are less flexible. The borrower is required to have a consistent income, a credit score of 620 or higher, and a debt-to-income ratio of 45% to 50%. Conventional loans are provided by your lender based upon guidance from Fannie Mae and Freddie Mac which are private companies with partial government backing.

If you’ve spent some time establishing your credit score and saving up a down payment, a conventional loan qualifies you for more favorable loan conditions and gives you more property options. With a down payment of at least 20%, you can avoid the private mortgage insurance requirement — and with a score of 740 or higher, you may qualify for a lower interest rate.

If the home you chose is located in a residential area with many recent home sales, Fannie Mae or Freddie Mac may be able to provide an automated home valuation without requiring a physical appraisal so you can save money on paying for an appraisal and do not need the appraiser to come to your home. Ask your lender about the possibility for a “Property Inspection Waiver.

Pros:

• Works for primary or secondary residences and investment properties
• Option to pay as little as 3% with Fannie Mae or Freddie Mac-backed loans
• Option to cancel mortgage insurance upon 20% equity
• Lower borrowing costs
• Less stringent appraisal requirements

Cons:

• Higher credit requirement
• Strict DTI standards
• PMI requirement with <20% down payment
• Full documentation required

Conventional Mortgage Vs. FHA Loan

Determining whether an FHA or a conventional mortgage loan is a better fit comes down to your own personal finances.

If you are re-establishing credit or in the process of saving for a down payment, an FHA loan is flexible with credit score and lower down payment options. But remember, FHA loans require mortgage insurance.

If you’re after a home that doesn’t quite meet the government property requirements of an FHA loan (by way of example, FHA Appraisals have specific requirements for homes and well/septic systems, while conventional appraisals do not), a conventional mortgage will give you the freedom to buy that property. If you don’t want the expense of private mortgage insurance, you can avoid paying it with a 20% down payment under a conventional loan, while an FHA loan will require mortgage insurance regardless of the down payment you provide.

VA Loans

As a benefit for military service, the Department of Veteran Affairs offers loans to veterans (either currently enlisted or discharged) that the VA partially guarantees and that provide specific perks not available with FHA or conventional financing. VA loans don’t require a down payment, minimum credit score, maximum debt-to-income ratio, or place any limits on how much you can borrow — so long as the lender is willing to lend it to you. VA loans also don’t require mortgage insurance, which helps veterans save more money each month.

However, a mandatory VA funding fee is needed to fund the program. The fee is usually 2.3% of the loan amount, and it can be rolled into the loan. For those who have disabilities related to their military service, that fee could possibly be waived.

Pros:

• Attractive terms and interest rates
• No mortgage insurance requirement
• No down payment required
• No early pay-off penalty

Cons:

• VA funding fees
• Can’t be used for rental properties
• Property condition requirements
• Mandatory move-in deadline

VA Mortgage Vs. Conventional

When comparing VA and conventional loans, the decision may seem like a no-brainer. The VA loan has no mortgage insurance requirement, no down payment, and favorable interest rates, making it seem like the clear-cut choice — however, it isn’t always the best option.

VA loans are not available for investment properties or fixer-uppers unlike conventional loans. VA loans also require you to move into your residence within 60 days of closing, so if you can’t, this loan may not be ideal.

If you’ve saved enough to provide a 20% down payment, it may be more beneficial for you to choose a conventional loan. Opting out of a down payment through the VA loan can cause you to miss out on equity, which means you might lose home value and end up having to put cash into the sale of your home. A down payment will also eliminate the private mortgage insurance requirement. Plus, when you borrow less, you also pay less interest over time.

Questions? We Simplify Home Loans

Home financing can be overwhelming, especially as a first time home buyer. Our mission is to simplify mortgage lending so you can enjoy the process and achieve your dream of homeownership. If you have more questions about these loans, give us a call today. We’ll make your loan mission possible.

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