Sunday, 2 August 2020

Differences Between FHA, VA, Conventional


In this article, we're talking about the differences between FHA, VA, and Conventional types of financing. Now, chances are if you're a homebuyer, and you'll begin to talk to lenders about your home loan, you're going to land one of these four options. So let's take a look at what they are.


What Are The 3 Types Of Mortgage Loan?


  • FHA
FHA stands for the Federal Housing Administration, and it's been around since 1934.

  • VA
Which is overseen by the US Department of Veterans Affairs? Oversees everything to do with veterans.

  • Conventional
Is overseen by Fannie Mae and Freddie Mac. We'll explain shortly what those are.

Understanding How Money For Home Loans Is Provided In The U.S.

Before we can really understand these different types of loans, we need to take a step back and get an understanding of how historically, home loans have been provided and sustaining this country. Now, when a loan is funded, the investment made by that bank is backed by an investor. This means that rather than having to wait 30 years to get the original principal balance in the interest back, the bank could make some immediate money, by selling the right to collecting those interest payments to an investor, and that investor is in it for the long haul. Now, in other words, another investor comes in, buys the debt, and the right to collect payments on it. Why is this important? It's important because the local bank or mortgage company or credit union can make their money back immediately, and return to the business of helping the next homebuyer without tying up their money for 15 to 30 years which is an awfully long time. 

Now, how do banks get their money back immediately?. And how do they continue to provide loans?. Historically, what the banks did, was reach out to a middleman that bought these loans thousands upon thousands of them, good loans, bad loans, all mixed up together, and then they played the role of finding investors for these loans all across the world. Now imagine these mortgage loans as red apples, green apples, yellow apples, bad apples, good apples, old apples, organic apples, all mixed up in one bag, and the middleman takes that bag, and slices it up in little bags, small groups of loans, and sells them to end investors all over the world. Now, the middleman by playing that role enables both the big and small banks to keep lending money, because it's always a constant supply of cash to come, and replenish the money that they've lent out. 

3 Major Companies Who Played The middle-Man Role

In the U.S. historically, there have been three major companies that played that middleman role, or they back private companies that play the role;
  1. Fannie Mae 
  2. Freddie Mac 
  3. Ginnie Mae 

Now let's talk about the last one first 

Ginnie Mae

Ginnie Mae stands for the government National Mortgage Association. Actually a government agency within HUD. Now, Ginnie Mae backs certain types of mortgages that have bought and sold all over the world. The end investor who buys the loans whether they're a pension fund in Germany, or an insurance company in China, for example, those end investors carry less risk because the Full Faith and Credit of the US government is behind these loans that are bought and sold. Essentially, the US government is guaranteeing the monthly payments to the holder of that bag of apples, the pool of mortgages. Now, what does this mean on the street? How does this affect the home buyer qualifying for a mortgage?. Get this loans backed by Ginnie Mae carry more flexible underwriting guidelines, and lower interest rates or better pricing, we'll explain in just a little bit. Unlike Ginnie Mae, Fannie Mae, and Freddie Mac, the other two companies that are playing that role at middleman role of buying and selling mortgages in bulk, they have government oversight and often even government intervention like we've seen in 2011 2010, but they are not actual government agencies. The loans that they buy, and sell across the world are not 100% backed by the US government, and so their standards and their guidelines are tighter.

Now, which loans are backed by Ginnie Mae, and in which not. In other words, for which loans does our federal government come in, and provide a guarantee to the end investors saying, hey, if payments stop coming in, we will step in, and make good. Which are those loans? The answer, FHA, VA, and USDA. And this makes those mortgages less risky to the end investors, which in turn means lower pricing on the street, better and easier qualifying for the borrower for the home buyer on the street.

Fannie Mae and Freddie Mac, 

Overseen loans are considered "conventional". In 2011 and 2010 the government actually announced that Fannie and Freddie will gradually be phased out or wound down, and this is going to leave our economy depending on other sources to play that role of providing mortgage money to the banks by packaging those pools of mortgages, and selling them off to investors all over the world.


Let's take a look at

FHA

As we've already said, because the lender has the full backing and guaranty of the US government behind the loan, they can tolerate more risk, and allow lower down payments when considering FHA financing. Now there are different types of FHA mortgages, but the most common is the FHA 203b, which as a 30-year and a 15-year fixed loan option.


Let's look at the pros and the cons of FHA financing 

Pro's Of FHA Financing

  • Low Downpayment: As low as 3.5%, allowing for 96.5% financing 
  • Flexible & Forgiving Underwriting Standards 
  • 2 years from a Bankruptcy Discharge and 3-years from a Foreclosure 

  • Non-Occupant Co-Borrowers Allowed
FHA allows for nonoccupant Co-borrowers, in other words, typically family members, can come in, and cosign for a borrower without even intending to live in the property. And what FHA allows is for the lender to blend the total income of all the borrowers, and the total debt of all the borrowers, and in doing so, the strength of the nonoccupant borrower can even out the weaknesses of the occupant borrower

  • Less Credit depth
Less credit depth is still acceptable, and it's not always necessary to have a high FICO score, in fact, FHA loans can be made to borrowers who have no traditional credit, such as credit cards, student loans, auto loans, and so on, and so forth. 

  • Non traditional credit = ok
FHA loans can be made to borrowers that have nontraditional credit, such as, utilities, rent history, car insurance, cell phone subscription, so on so forth.

  • The seller can contribute 6% towards closing cost
FHA allows the seller to give up closing cost concessions up to 6%, even at the highest loans of the value of 96.5% and we'll see a little bit. how that's unique.

  • Entire downpayment can be gifted to the buyer!
The entire down payment from the buyer can be gifted. This is in stark contrast to conventional loans where, typically, at least the first 5% of the down payment has to come from the buyer's own funds.

  • Certain debt payments can be eliminated if deferred
With FHA certain debts if they deferred can be taken out, eliminated from the monthly payment obligations, such as, for example, student loans 

  • FHA Streamlines - easy way to lower payments later
FHA has a streamlined feature whereby after six timely payments if the market rates have dropped, the FHA loan can be refinanced without an appraisal, and with very lean credit qualifying to lower interest rates, very attractive. It's a way for borrowers to get in with an FHA program, and if the rates improve, if the market improves, they can take advantage of that drop their monthly payment without having to go through a full-blown refinance.

  • No Cash Reserves required
Finally, when we're talking about the pros of FHA financing. FHA loans don't require any cash reserves in the bank, even $1 over what's needed for the down payment and closing costs to close the transaction is perfectly acceptable 


Con's Of FHA Financing

Let's look at some of the negatives 

  • Lot Pickier on the Property
FHA can involve the appraiser being a little bit pickier on the condition of the property. 

  • Restrictions on homes resold quickly for profit (aka "flips")
  • Mortgage Insurance on FHA loans continues for a minimum of five years even on a 30-year term
  • Upfront and annual mortgage insurance

  • Non-borrowing Spouse's debts to counted in some States
In the nine community property states, Arizona, California, Nevada Idaho, Louisiana, New Mexico, Texas, Washington, and Wisconsin, the spouse's debts have to be considered, which can often lower the amount an individual can qualify for. So even if you're borrowing and your spouse is not going to borrow on the loan, she's not going to sign, or he's not going to sign on the note, his or her debts monthly payments have to be counted against you, and that can lower your buying power possibly.

  • Loan limits typically lower than Conventional
The loan limits set for the counties of involving FHA financing are typically lower than what set by Fannie Mae and Freddie Mac in those same counties for conventional loans. For example, up until recently the max loan amount of conventional was $417,000 in many areas of the country.

  • Cannot finance 2nd Homes or Investment properties
FHA cannot be used to finance investment properties or second homes 


Conventional

Conventional low-interest rates tend to be a little bit higher because even though as we said before, a government-sponsored enterprise, ie, Fannie or Freddie. Backs these loans it's technically not the government that's guaranteeing them. Therefore, there's a little bit more risk to the investor which is reflected in the interest rate pricing adjustments, for example, there are adjustments to the interest rate for things like, loan-to-value, for example, an 85% loan to value, would have a higher interest rate more than likely than an 80%. 

Size of loan, in other words, the loan amount, the FICO score, higher FICO scores it'd have a better price in the lower FICO scores. Occupancy status. A loan requested to purchase a home as a vacation, or second home is going to add a little bit worse pricing that an owner occupying property pricing. Of course, the property type has an effect on the pricing as well.


Pro's Of Conventional Financing

  • There are less rigorous property appraisal requirements 
  • There's no upfront mortgage insurance
  • Typically higher Loan limits

  • Non-borrowing Spouse's debts Not counted
The spouse's debts do not have to be counted against the borrower when qualifying. If your spouse, your significant other, has monthly debts that are not reflected on your credit report, that does not have to lower your buying power

  • There's no mortgage insurance if you're borrowing 80% or below
That's in comparison to the FHA where with FHA, even at 80% loan to value, you have mortgage insurance for the first 5-years.


Con's Of Conventional Financing

  • Longer waiting times since Derogatory events, such as Bankruptcy, Foreclosure, Short-sale, Deed in lieu of foreclosure, etc.
  • Stricter credit requirements and tougher underwriting rules.
  • Borrowers for conventional financing have to have a pretty good credit history in high credit scores.

  • Private Mortgage Insurance = Not automatic! Can be denied
Private mortgage insurance, also known as, PMI, is not automatic with conventional financing. Now there are various PMI companies, such as Genworth, MGIC Radian, etc. And once the conventional underwriter at the mortgage company has approved the file. The PMI company itself has to underwrite the file according to that standards before the mortgage insurance certificate can be issued. So it's not always automatic, and there are instances where the loan will get approved by the underwriter, and the PMI company want to or can't issue the mortgage insurance certificate, and you pretty much have a dead deal.

  • Nonoccupant co-borrowers not allowed
Another con is that nonoccupant co-borrowers are not allowed on owner-occupied transactions, which is this is different from FHA's we discussed.

  • No Score = not allowed
Borrowers with no scores, and no traditional credit, cannot be approved typically. And they may have to resort to special conventional programs, niche programs, that carry higher interest rates, such as, my community.

  • Higher debt ratios = difficult to approve
There's less of a tolerance for high debt ratios, in fact, the automated system that Fannie Mae use is known as "Dee you" that you might have heard about, has become tighter, and tighter, over the years. Where higher debt ratios that used to pass through are now getting inter stopped at the door. And typically, you have to have a debt ratio of 45% or less, to be able to get through on a conventional loan.

  • Cash reserves often needed
Until the loan to value drops to 80%, the seller can only contribute 3% of the purchase price towards the closing cost.


VA

VA loans are for those who have or are presently serving in the Armed Forces of the US. If discharged. That discharge must be something other than dishonorable. As shown on the dd-214 separation papers for the veteran. The Department of VA actually gives the lender a guarantee up to 25% of the loan amount, so this usually means, if the home would have fully closed, and the Linder ended up selling it at 75% of the value, it would still make out okay because it would recover the other 25% directly from the VA. Now, in order to obtain a loan guaranteed by the Department of VA. The veteran must provide what's called a "COE", also known as a (Certificate Of Eligibility) looks something like this below


The COE is something your lender can get for you through the internet, online, as long as you provide the pertinent data. The coe, the Certificate of Eligibility, actually shows the entitlement amount that is relevant to that veteran, and then there's a magic formula that takes that entitlement and turns it into a maximum loan amount in that county for that veteran. Up to 100% financing, for example, recently in California most counties had at least a $417,000 max loan. In some counties had as high as $625,000, and north and northern Califonia some of the more affluent counties if you would. The veteran could borrow up to a million dollars with no money down. Pretty amazing. 

Now the VA helps cover the administrative cost of the program by charging a one-time upfront VA funding fee. For the first-time veteran use it, this was recently 2.15% of the loan amount, and for repeat users, as high as 3.3%



Pro's Of VA Financing

  • Lower Rates, Better Pricing
Just like FHA, VA loans are ultimately backed by none other than the US government Ginnie Mae. The rates tend to be lower, and riskier credit profiles are accepted. 

  • Only 2 years since Foreclosure and/ or Bankruptcy
Veterans with bankruptcies as recent as two years, and even foreclosures as recent as two years old, can be eligible for VA financing.

  • They can borrow 100% of the purchase price.

  • Seller Can Give Up 4% + 4% In Total concessions for Veteran Buyer
The seller can pay not only 4% towards the customary closing cost, but check this out folks, but also another 4% towards concessions, such as paying off the veteran's debts to enable him or her to qualify. In other words, the seller can assist in paying off the veteran's credit card debt, for example, to help that veteran qualify. So if you add 4 and 4 together, that's a total of 8% of the purchase price in seller concessions that can be given up, very attractive for veterans to get into the home with VA financing.

  • No Cash Reserves needed

  • Windows of Deceased Veteran
VA can be funded for widows of deceased veterans who never remarried

  • No Credit score/ No traditional credit 
Veterans without credit scores or traditional credit can be eligible as well. Just like with FHA as we discussed earlier.

  • No Mortgage Insurance
There is no mortgage insurance even at 100% financing, this makes it very attractive. No MI, there's no upfront MI, and there's no annual MI for VA financing.

  • Funding Fee Waived For Disabled Veteran
Veterans with service-related disabilities, 10% disability can have their VA funding fee waived if they can document that, and that means they're not borrowing exactly 100 percent of the purchase price, and nothing more.


Con's Of VA Financing

  • Non Veteran = not eligible
Only veterans or their spouses can be on the loan, no one else. You can't have a girlfriend, boyfriend, a family member, and you certainly can't have a nonoccupant co-borrower, whereas you can with FHA.

  • Spouse's debt to be counted (Community Property States)
In community property states, the spouse's debts just like with FHA loans remain earlier, have to be counted, and can lower the buying power.

  • The Property is Rigorously Inspected by the VA Appraiser 

  • Seller maybe behave unfavorably
In fact, some sellers tend to react unfavorably because of the stigma associated with VA loans for that reason, and it takes a well-skilled loan officer to get on the horn, get on the phone with the seller, and/or the seller's agent, and reassure them regarding VA financing. Obviously, you have to be a veteran, active duty, or reserves to be able to get a VA loan. It's not for everyone.





Conclusion

I hope you found this article helpful. Now you know the difference between these 3 mortgage loans.

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