Those considering refinancing for lower payments or change mortgage terms have different loan options, with FHA loans and conventional mortgages being the most common. The Housing and Urban Development (HUD) insures FHA loans against default, which allows lenders to modify certain criteria for borrowers, called overlays. The government does not back conventional loans, and they conform to separate lending standards. If a borrower chooses the wrong type of loan, the differences can be costly and have long-lasting effects. Below are some details on FHA home loans and their requirements.
Mortgage Insurance Rules for FHA and Traditional Loans
There are distinct differences between FHA loans and conventional mortgages, and borrowers should understand those differences so they can make informed decisions. The main difference between the two loan types is in mortgage insurance requirements. FHA loan requirements set forth a monthly mortgage insurance payment, which lasts for the entire loan term. Additionally, the borrower must pay a 1.75% fee upfront when they get a loan. With conventional loans, the lender must remove the insurance premium if the loan amount is brought down to less than 80% of the home’s purchase price or appraised value.
Credit Qualifying Criteria
Another significant difference lies in each loan type’s qualifying criteria. The Federal Housing Administration typically has lower credit score requirements than traditional lenders, and the waiting period after a foreclosure, short sale, or bankruptcy is shorter with an FHA loan. With conventional financing, a borrower must wait for seven years following a foreclosure to get prime rates, but with an FHA loan, the waiting period is only three years.
Down Payment Requirements
Down payment requirements are substantially different for FHA and conventional loans. With Texas FHA loans, the minimum down payment is 3.5% compared to a 5% requirement for a conforming loan. However, a low-down payment of 3% for a conventional loan typically comes with strict qualifying criteria, while FHA loans are more attainable. Unless a buyer has perfect credit, significant savings, and a steady, high income, they may find it easier to get a small down payment loan through the Federal Housing Administration.
The Advantages of Refinancing or Purchasing a Home with the FHA
For borrowers with less-than-perfect credit, FHA loans offer some significant advantages, such as those listed below:
- A small down payment: It’s possible to get an FHA loan with a 3.5% down payment.
- Modest credit requirements: Lenders accept borrowers with credit scores of 580 or less in many cases. Conventional loans require a minimum of a 620 mid-FICO score to qualify.
- Competitive rates: Federal Housing Administration loans have rates comparable to those offered by conventional loans.
Challenges to Consider With FHA Loans
While FHA loans are a great tool for many home buyers, there are some challenges to consider. Before getting a loan through the FHA, borrowers should be aware of the following factors.
Mortgage insurance is mandatory. All loans offered through the FHA require borrowers to pay monthly insurance premiums of about .85% of the loan value.
There’s an upfront funding fee for mortgage insurance. These loans come with an upfront payment requirement of 1.75% of the loan value.
The premium will not disappear. Unlike a conforming mortgage, where the insurance requirement is removed when the owner has sufficient equity in the home, FHA mortgage coverage premiums stay in place for the entire loan term.
Streamline Refinancing With the FHA
If a homeowner wants to refinance an existing FHA mortgage with another FHA loan, streamline refinancing is a viable option. According to HUD (the US Department of Housing and Urban Development), streamlining refers to the required paperwork, not the fees, costs, and lending criteria.
Cash Out Refinancing
A cash-out refinance (aka Texas section (a)(6) loan) is available to holders of conventional loans but not available for FHA loans in Texas. As implied by the name, this home lending option allows the borrower to cash out a percentage of his or her home equity. There’s a limit of 80% of the value of the property in cash out loans. If a borrower doesn’t know their loan to value ratio, they should consult a mortgage expert.
Home Improvement Loans
An FHA loan used to improve the functionality and features of the property is called the FHA section 203(k) loan. It combines both the cost to purchase or refinance a house plus the cost of its rehabilitation through a single mortgage. There are different types of 203(k) loans available, depending upon the actual needs to a borrower.
Some lenders offer a conventional home improvement loan, but that is far and few in between. The other option a borrower has is to take a cash-out loan or the section (a)(6) loan and use the proceeds to improve and rehabilitate their home.
Other Options: Is FHA Loan the Right Choice for Every Homeowner?
Because of the differences between FHA and conforming loans, it is important for borrowers to make a decision that suits their situations. While conventional loans have no upfront funding fee and a disappearing mortgage insurance requirement, they are not right for every homeowner. If a borrower has damaged credit due to foreclosure or bankruptcy, FHA lending is easier to obtain at a lower rate.
Some borrowers may be eligible for low-interest, one hundred percent financing home loans through the VA or USDA. HARP is also available for some homeowners. VA loans are guaranteed by the US Department of Veterans Affairs, and they make it simpler for active duty military members and veterans to get a loan to buy or refinance a home. USDA loans are home loans guaranteed by the United States Department of Agriculture. The property must be located inside the USDA eligible area map to qualify for USDA financing. HARP (the Home Affordable Refinance Program) is a government-backed program that helps borrowers with very little or no equity in their home, refinance their loan to a lower rate, thus, lowering their monthly payments, without an extra mortgage insurance.
Even if a borrower finds it difficult to get a conventional mortgage to refinance a home or make a new home purchase, there are several options. With FHA loans, borrowers with marginal credit can buy a home or make their current mortgage easier to afford.