|Conventional vs. FHA
Which loan is really right for your situation?
There used to be that if you didn't have great credit you would go with a smaller down payment and an FHA loan. Then conventional zero downs were such a new thing that most homebuyers went that route... but now you have to have pretty good credit again to qualify for those loans. So what is the deal with the FHA now?
The news reports are grim: Not only have dozens of sub prime lenders closed their doors or cut back sharply on new mortgage offerings, but they're also severely tightening the loose underwriting standards that got them into trouble.
As a result, many people who would have been approved for a loan months ago now find that their credit isn't stacking up.
But here's some potentially helpful news: There is a mortgage source that is actually expanding its business nationwide for credit-impaired and first-time home purchasers.
That source is the golden oldie of the mortgage arena — the Federal Housing Administration (FHA), which recently has seen a doubling of customers refinancing out of private, sub prime loans into its insured mortgage programs.
The REASON: FHA doesn't have problems with Wall Street investors who now see sub prime mortgage bonds as bad investments. FHA's bonds, by contrast, are backed by the federal government so there's no shortage of mortgage money. Equally important: FHA-insured loans are more consumer-friendly than sub prime, and come with interest costs roughly 3 percentage points below directly comparable sub prime mortgages.
The DRAWBACK: FHA mortgage maximums top out just under $363,000 or around there depending on what part of the country you are in. In the highest-cost markets, an FHA loan will let you buy only a modest starter home. Yet in more typical markets around the country, FHA's limit is not a big problem since most first time homebuyers are not spending that much anyway. FHA's maximum loan amounts are likely to increase: Bipartisan legislation to raise the loan ceiling to the full Fannie Mae-Freddie Mac limit — currently $417,000 — is expected to soon be introduced on Capitol Hill, and appears to have support for passage this year. Unlike many sub prime mortgage programs, FHA does not allow consumers to buy a house without putting something into the deal. Down payments generally are 3 percent, although the forthcoming congressional legislation is expected to lower that threshold. The inspections are also more rigid so you can't be looking into a "fixer" and expect FHA to cover it. They don't have the guarantee you are going to fix it up for them.
Another drawback and the major differences between FHA mortgages and conventional is that you can't just "state" your income and get a loan with no documentation. You've got to show proof that you earn what you say, and can truly afford the house you want to buy. There is no liberal payment plan where you can send what you want and get away with it that month or the next. Also differing from conventional and sub prime lenders is that FHA does not set rates on the basis of FICO credit scores; instead it underwrites loans using what it calls a "total scorecard" that examines an applicant's full credit history, employment and nontraditional credit patterns such as rent and utilities payments. But, it does not disqualify anyone automatically because of a bankruptcy, and it emphasizes a holistic "compensating factors" approach to credit decision-making.
- So when buying a home you might ask your agent or lender if an FHA is right for you. While FHA is cutting out the red tape, speeding up processing and is eager to expand its business to credit-worthy borrowers who are willing to put a little of their money into home purchases.
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