There are many different loan products available to homebuyers today…so many that it can be confusing. Basically, there are two main types of mortgages, government backed mortgages, like VA, FHA, and USDA, and non-government backed mortgages, or conventional loans. Let’s break down all the categories and see what is the difference between FHA and conventional loans.
For first time home buyers, and even experienced homebuyers, the terminology of loans can be confusing, and sometimes the answers are misunderstood when explained in real estate jargon. Here’s a brief rundown:
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FHA, VA, and Conventional Loans
Of all the loans that are originated in residential home sales, FHA, VA and Conventional are the most popular, and most familiar to homebuyers. There are many sub-types of loans within these three that we will cover below. Let’s go over the main points of these three loans.
1. FHA – Insured Financing
FHA Loan: Insured by the FHA, this mortgage option allows for a lower down payment (as low as 3.5% of the purchase price). It is designed to help first-time homebuyers and individuals with lower credit scores.
FHA stands for Federal Housing Administration and was created in 1934. The Federal Housing Administration doesn’t actually lend money to home buyers. Rather, it insures the loans that are given to qualified home buyers, by FHA-approved lenders. FHA loans are a type of government assistance and have lending standards that are less stringent than other types of loans.
The minimum credit score of 580 is a bit lower than that required by lenders of conventional loans. [And 580 is just the FHA’s guideline – individual banks and mortgage lenders still need to agree to offer such loans. So there’s a very good chance you’ll need an even higher credit score.]
Also, the credit score isn’t the only aspect of the buyer’s credit-worthiness; FHA takes into consideration the buyer’s payment history, and what they refer to as common sense lending standards. If you have had credit problems in the past, the FHA recommends a Consumer Credit Counseling program to avoid being denied an FHA loan.
The down payment required on an FHA loan is 3.5%, this is less than conventional loans. The maximum seller contribution allowed is 6%.
Historically, FHA-insured loans have made it possible for lower income Americans to purchase a home that they otherwise wouldn’t have been able to afford. FHA loans are the most popular choice of first-time home buyers, mainly because they often don’t have the money for a higher down payment. They also don’t have the mortgage history which so often helps in building a higher credit score.
In today’s real estate market, many first time buyers are opting for FHA loans with lower down-payments. Rather than waiting to save enough for a 20% down payment that is necessary for many conventional loans, taking advantage of an FHA loan at today’s interest rates is a smart move. In the time that it would take to save that amount, higher interest rates will very likely mitigate against the monthly savings from a higher down-payment.
FHA loans require private mortgage insurance to protect lenders from possible default. Every month, a mortgage insurance premium, MIP is added to the monthly payment. This mortgage insurance was just lowered in 2015 from 1.35% of the premium amount, to .85%. This will save an average of $900 a year.
The other change that just took place is that the MIP is now a permanent part of the loan. Previously, the MIP was dropped from the monthly payment when the loan was paid down to the point where the buyer owed less than 78% of the original loan. The UPMIP (upfront MIP) is currently at 1.75% of the base loan amount.
FHA has loan limits, which are different, based on local markets.
Local Maryland Loan Limits:
The limit for Frederick County and Montgomery County in 2023 is $1,089,300. Calvert, Charles and Prince George’s Counties have limits of $1,089,300.
Howard, Carroll, Anne Arundel, Baltimore and Washington Counties conforming loan limits will be $726,200, as well as all other counties in Maryland.
2. VA Loans – Loans for Veterans and Current Servicemen and Women
VA (Veterans Affairs) Loan: Available to eligible veterans, active-duty service members, and their surviving spouses, this loan is guaranteed by the Department of Veterans Affairs and often offers favorable terms, including no down payment and competitive interest rates.
Since 1944, introduced in the GI Bill of Rights, the Housing Administration has been providing VA guaranteed loans for our Veterans. Like FHA loans, VA loans are made through approved private lenders. The guaranty to lenders means in both VA and FHA loans, the lenders are protected against loss in case of the default of the buyer.
VA loans are the only loans today which offer a no-down payment loan, no MIP, and often have a lower interest rate. VA loans require no private mortgage insurance, and allow financing up to 103.3% of the value of the home.
The VA does not have a minimum credit score used for pre-qualifying for a mortgage loan, however, most Lenders require a minimum credit score of at least 620.
The maximum amount of a VA home loan is typically $417,000, although it can be higher in certain “high-cost” counties. In Hawaii and Alaska, for instance, the limit is $625,500.
Both VA and FHA have their own guidelines which describe all allowable loan traits, as well as the going terms of an Federal Housing Administration-backed loan. The rules can differ regarding closing cost help, property condition, and type of property that can be financed, as well as other items.
Other Types of Government-Backed Mortgage Loans
USDA (United States Department of Agriculture) Mortgages
These loans are designed to help rural and suburban homebuyers with low to moderate incomes. They offer no down payment options and competitive interest rates.
3. Conventional Loans
Conventional loan products are not guaranteed by the VA or insured by the FHA. Also called a non-GSE loan, non-government sponsored entity. Private, conventional loans are secured by investors. Thus, the requirements are often more stringent than FHA or VA loans.
Unlike FHA loans, conventional loans can be used for second homes and investment properties. The minimum credit score is typically 620.
Conventional loans have various terms and loan-to-value ratios. Loan-to-value ratio (LTV) means how much you are borrowing compared to the overall value of the home. The more you put down, the lower the LTV. The higher the LTV, the more risk the lender is taking, and the more costly the loan for the buyer, in terms of interest rate.
The down-payment required on a conventional loan can vary. It typically requires a down payment of at least 5% to 20% of the home’s purchase price. Private mortgage insurance (PMI) may be required if the down payment is less than 20%.
The Conventional 97 program only requires 3% down, and is available to U.S. homebuyers through Fannie Mae and Freddie Mac. Conventional loans can cover much higher loan amounts than FHA, called Jumbo loans, and offer more types of loans.
If the LTV is lower than 80%, the lender often requires that borrowers pay for private mortgage insurance, or PMI. The PMI is only a single premium, whereas with FHA, there are both upfront and monthly premiums, and the PMI with FHA loans never drops off. The term of the loan can be longer or shorter, 15 years, or 30 years or even 20 or 40. With each there are different interest rates.
- Fixed-Rate Mortgage: In a fixed-rate mortgage, the interest rate remains the same for the entire loan term. This provides stability as the monthly payments remain constant throughout the loan period, usually 15 or 30 years. We have lately seen some usage of a 40 year mortgage, as an attempt by lenders are making it more affordable with the soaring home values in some areas of the country.
- Adjustable-Rate Mortgage (ARM): An ARM has an initial fixed-rate period, often 5, 7, or 10 years, after which the interest rate adjusts periodically based on prevailing market rates. The monthly payments can change over time, depending on the interest rate fluctuations.
- Jumbo Mortgage: Jumbo mortgages are used when the loan amount exceeds the conforming loan limits set by Fannie Mae and Freddie Mac (conforming loan limits: $1,089,300 in Frederick and Montgomery Counties as of 2023). Jumbo loans usually have stricter qualification requirements due to the higher loan amounts involved.
- Interest-Only Mortgage: With an interest-only mortgage, the borrower pays only the interest for a certain period (usually 5 to 10 years). After the interest-only period, the borrower must start making principal payments, which can result in higher monthly payments.
- Balloon Mortgage: A balloon mortgage has a fixed-rate for a specific period (e.g., 5 or 7 years), but at the end of the term, the remaining balance becomes due in a lump sum. Borrowers often refinance or sell the property before the balloon payment is due.
- Reverse Mortgage: Primarily available to homeowners aged 62 and older, a reverse mortgage allows seniors to convert part of their home equity into cash. The loan does not require monthly mortgage payments but must be repaid when the homeowner moves out or passes away.
These are some of the common types of mortgages available to homebuyers. It’s essential to research and compare different options to find the one that best suits your financial situation and long-term goals. Before making any decisions, it’s wise to consult with a qualified mortgage professional or financial advisor.
Ask Your Lender
Your lender can help you determine which loan product is best for your needs. Your loan officer will be able to tell if you qualify for both types of loans, and determine which will cost less both short and long-term. Ask for a side-by-side cost analysis.
If you are ready for a home purchase in central Maryland, give us a call. We offer buyer representation and sound advice about today’s Central Maryland real estate market. Feel free to contact us for our pick of superior local lenders. Use our Property Search to find your new Frederick Home:
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