FHA Loans

FHA versus Conventional Loans - Differences in Loan Guidelines

Although there are similarities between all mortgage loans in general, there are also some big differences.

• FHA mortgage rates are generally a little better than conventional mortgage loans
• Interest rates don't increase for lower scores, like a conventional loan, until your score gets below about 640
• Credit guidelines are less restrictive
• Higher debt-to-income ratio's allowed
• Lower credit scores are acceptable.
• Shorter waiting period after a bankruptcy or foreclosure

For example, an FHA loan allows for borrowers with less just OK credit to receive the same interest rate as a borrower with great credit.  On a conventional loan, for ever 20 point lower score, starting at 740, the interest rate start to rise on conventional loans. FHA is also more forgiving on past major credit issues. FHA allows someone with a bankruptcy to potentially get a new loan in as little as two-years after the bankruptcy.  For those with a previous foreclosure, FHA loans are possible just three-years after the Sheriff sale date.

FHA loans also have some negatives which need to be understood too:

• More picky about property condition (like peeling paint on older homes)
• Mortgage insurance is life of loan with small down payments
• Mortgage insurance is for no less than 11-years with larger down payments

Everyone understands down payment, but many first time home buyers are shocked to discover there are costs to get a mortgage loan, and these costs can sometimes be more than the down payment.

Typically borrower must pay, at the time of purchase, the costs and charges associated with buying a home. Commonly these costs are referred to as closing costs, which need to be paid in order to get the loan. Some of these costs  include appraisal, credit report, origination fees, title company fees, state taxes, county recording fees, etc. You also have to pay for your first years homeowners insurance, and pre-rated property taxes up-front when buying a home.

Your closing costs can be paid five ways:

• Cash out of pocket
• Rolled into the loan - commonly called Seller Paid Closing costs (which really just means they are financed into the loan).
• Rolled into a slightly higher interest rate
• Use a down payment and closing cost assistance program
• Any combination off all of these items

Most of the time, people use a combination of all these to either eliminate, or seriously reduce the money needed up-front to buy a home.

Seller paid closing costs 

Seller paid closing costs is a means of which you are financing the costs into the loan, versus paying out of pocket today. You usually have to add the amount you want rolled in on top of your offer price. For example, say you need $6,000 worth of closing costs paid, and the seller is asking $200,000 for the home. Your offer would be $206,000. It is called seller paid closing costs because on the actual purchase agreement, it is written that the seller would pay your $6,000. 

As you can see, the seller got the exact $200,000 they were asking for and you financed $6,000 into the loan.

FHA allows you to roll in up to 6% of the homes purchase price, with conventional only allowing 3% with down payments less than 10%.

FHA was created by the Federal Government to provide affordable housing financing for qualified borrowers. FHA doesn't actually lend, they just insure part of the loan, reducing the lender's risk. To cover the cost of the program, the new home owner pays into the program with Mortgage Insurance.

There are two aspects to FHA mortgage insurance. The first is an upfront insurance premium, called MIP, which can be paid in cash at closing, or added to the loan amount. Almost everyone elects to roll it into the new loan amount, so it is not an out-of-pocket expense. The borrower also pays monthly mortgage insurance. These funds go into a default pool, while covers any foreclosures, and all FHA borrowers have to pay into this fund.

FHA mortgage insurance has changed over the year, the most current change took effect in 2023, FHA mortgage insurance is required on all FHA loans, regardless of down payment size.

FHA Up front mortgage insurance premium (UFMIP)
FHA upfront mortgage insurance premium is 1.75% of the loan amount on purchase loans, and again, is usually rolled into the new loan.

Streamline refinance is .55%. But streamline refinance of FHA loans originally done prior to May 31, 2009 is just .01%.

FHA monthly mortgage insurance costs: (current as of 2023)
FHA monthly mortgage insurance varies depending on the loan type, and loan-to-value.

How To Calculate FHA Mortgage Insurance:

Take loan amount times mortgage insurance factor, then divide by 12 to get amount monthly. For example, a $100,000 loan, with a .75% factor ($100,000 x .0075 = $750/yr, Divided the yearly amount by 12 = $62.50 a month in mortgage insurance added to your home payment.

FHA loans are not technically bad credit loans.

FHA is your best option if you are a weak credit risk, but it is NOT a bad credit loan. You have to qualify, it has to make sense, and you have to have a little skin in the game (down payment). FHA allows for a small down payment of just 3.50% with credit scores ABOVE 580, and at least a 10% down payment with credit scores from 500 - 579.

While technically possible to be approved on an FHA loan with a low score, understand that credit score alone does NOT equal a loan approval. Every little drop in credit score below about 620 makes getting an approval harder and harder.

Call us at (651) 552-3681 to discuss any low credit score situation - we'll help determine if you should apply.