It would be great to have loads of money just sitting in your savings account waiting to put a big down payment on your dream house. But for a lot of people that kind of reality doesn’t exist.
That’s one reason why buyers turn to Federation Housing Administration (FHA) loans because they offer the advantage of only putting down 3.5 percent. That can make a big difference in someone’s budget. For instance if the loan you want to take out on a house is $200,000, the FHA loan would only require a $7,000 down payment. For those trying to avoid any mortgage insurance premiums would have to put down 20 percent on a conventional loan – that would be $40,000 down payment.
“In my experience, the majority of people purchasing a home with an FHA loan, usually put down only the 3.5 percent and not any more,” says John Moony, vice president of mortgage lending at Guaranteed Rate in Chicago. “If a customer has 5 percent down payment and a strong credit, typically it might make more sense to go with a conventional loan.”
FHA loans are more forgiving of credit score and someone’s debt-to-income (DTI) ratio. FHA also gives someone a really attractive interest rate even with a pretty low credit score. Plus, FHA allows that 3.5 percent down payment to come from a gift from a close relative or friend, Moony says.
Low Down Payment Conventional Loan Option
With most conventional loans, lenders require you to have your own funds saved up for these costs. Some allow for some financial help from others, but it has to be documented and usually not for the entire cost, he says.
The new conventional 97 percent loans being made available by Fannie Mae offer loans for only 3 percent down – plus these loans also allow 100 percent gift from relatives.
“The benefit to these conventional loans with only 3 percent down is eventually the mortgage insurance will go away. But with FHA loans, you are paying the mortgage insurance for as long as you have that loan,” Moony says.
Conventional Loans have Higher Credit Score Requirement
The conventional 3 percent loans would require a much higher minimum credit score of 680 or better. And if you decide that down payment will be coming from a relative, your credit score must be much higher – at least 740. So, those with lower credit scores are back to the FHA loans to help them out.
“The FHA guidelines say that a 580 credit score is accepted. But what FHA guidelines allow and what the banks actually accept are two very different things,” Moony says. “Borrowers really need to talk to someone that knows how different banks handle FHA products.”
Fannie Mae and Freddie Mac offer basic 5% down mortgages. And if you are lucky enough to be eligible for a VA or USDA loan, you aren’t required to put down any money for a mortgage. But remember the less you put down in the beginning, the higher your monthly payments will be.
FHA Advantages Beyond a Low Down Payment
Another advantage of FHA loans is that they are much more forgiving of bad financial events such as a bankruptcy. Moony shows how many years must pass before you can start to qualify for certain mortgages:
Bankruptcy: One or two years for FHA, depending on whether Chapter 7 or Chapter 13; Two or four years for conventional loans.
Foreclosure: Three years for FHA; seven years for conventional.
Short Sale: Three years for FHA; four years for conventional.
Moony also sees an FHA loan as the loan for people who want to get into a house quicker than with a conventional loan. This is true for those who just started a business a year ago or so, and are actually making income. Conventional loans won’t take anyone that doesn’t have two-years at the same job or profession. FHA loans are less restrictive and can qualify someone on their income in different ways than the less lenient conventional loans.
Also, FHA loans require that the house meet certain conditions and must be appraised by an FHA-approved appraiser.
“Historically, a lot of realtors shied away from FHA loans,” Moony says. “The agents feel like an FHA appraisal will be more scrutinized. That’s not always the case. I don’t see a whole lot of stipulations on FHA appraisals that are different from regular appraisals.”
Qualify for FHA
Homeowners with very little down payment or so-so credit scores can still qualify to buy with an FHA loan.