Today we’re talking about the differences between FHA, VA, conventional and USDA types of financing. Now chances are if you’re a homebuyer and you’ll beginning 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.
FHA every chase 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 and we’ll explain shortly what those are and USDA which is overseen by the US Department of Agriculture.
Now 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.
now 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 awful 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.
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.
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. 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 Fannie Mae, Freddie Mac and Ginnie Mae.
Let’s talk about the last one first Ginnie Mae. Ginnie Mae stands for government National Mortgage Association actually a government agency within HUD. 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. 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 and we’ll explain you in just a little bit why.
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. 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.
Now Fannie Mae and Freddie Mac overseen loans are considered conventional. In 2011 and 2010 don’t go off the tangent here, the government actually announced that Fannie and Freddie will gradually be you know 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. There’s different types of FHA mortgages but the most common is the FHA 203k year and a 15-year fixed loan option.
Now let’s look at the pros and the cons of FHA financing folks. pros lower down payments as low as 3 to 5 percent allowing for ninety six and a half percent financing flexible and forgiving underwriting standards including two years from a bankruptcy, discharge and three years from a foreclosure FHA allows for non occupant core 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 non occupant borrower can even out the weaknesses of the occupant borrower.
Now 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 borrow us. We have no traditional credit such as you know credit cards, student loans and auto loans and so on and so forth FHA loans can be made to borrowers that have non traditional credit such as utilities rent history car insurance, cell phone, subscription, so on so forth.
Now FHA allows the seller to give up closing cost concessions up to 6%, even at the highest loans of value of ninety six and a half percent and we’ll see a little bit how that’s unique the entire down payment from the buyer can be gifted. This is in stark contrast to conventional loans where typically at least the first five percent of the down payment has to come from the buyers own funds.
Now with FHA certain debts if they deferred can be taken out eliminated from the monthly payment obligations such as for example student loans fhe 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. Finally when we’re talking about pros of FHA financing FHA loans don’t require any cash reserves in the bank even one dollar over what’s needed for down payment and closing costs to close the transaction is perfectly acceptable.
Let’s look at some of the negatives FHA can involve the appraiser being a little bit picky err on the condition of the property. There are restrictions on buying homes that are being quickly resolved for-profit. In fact we have a whole other video home buyer webinar tutorial on FHA flipz, where the seller has not owned the property for 90 days.
The sellers reselling the property for profit within 90 days of acquiring it and you want to take a look at the details their mortgage insurance on FHA loans continues for a minimum of five years even on a 30-year term and and there’s an upfront mortgage insurance and an annual mortgage insurance.
Now 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 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 your buying power possibly.
Now 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 the max loan amount of conventional was four hundred and seventeen thousand in in many areas of the country. FHA cannot be used to finance investment properties or second homes.
Let’s talk about Conventional folks. Convince low interest rates tend to be a little bit higher because even though as we said before a go sponsored enterprise ie Fannie or Freddie backs advised 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 you know for example an eighty five percent loan to value would have a higher interest rate more than likely then an eighty percent size of loan.
In other words the loan amount the FICO score high-fiber scores it’d have better price in the lower FICO scores occupancy status alone requested to purchase a home as a vacation or a 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 we’re talking conventional.
Now let’s look at the pros and cons of conventional financing pros. there are less rigorous property appraisal requirements there’s no upfront mortgage insurance. there are higher loan amounts typically and here’s a really good one the spouses debts do not have to be counted against the borrower when qualifying.
So if you 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 and finally there’s no mortgage insurance if you’re borrowing eighty percent or below and that’s in comparison the FHA where with FHA even at eighty percent loan to value you have mortgage insurance for the first five years.
Okay let’s look at the cons or the disadvantages of conventional financing typically longer waiting times since derogatory events such as bankruptcy foreclosure short-sale deed in lieu of foreclosure so on and so forth. stricter credit requirements and tougher underwriting rules typically borrowers a go for conventional financing have to have pretty good credit history in high credit scores private mortgage insurance also known as PMI is not automatic with conventional financing.
Now there are various PMI companies such as Genworth MGIC Radian and so on and so forth 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 another con is that non occupant call borrowers are not allowed on owner-occupied transactions which is this is different to FHA’s we discussed.
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.
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 can have to have a debt ratio of forty five percent or less to be able to get through on a conventional loan.
Now until the loan to value drops to 80 percent the seller can only contribute 3% of the purchase price towards the closing cost. let’s take a look at 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 full closed and the Linda ended up selling it at 75 percent of 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 if you take a look at your screen also known as a certificate of eligibility looks something like this.
Now the co is something you’ll lender actually can get for you through the internet through online as long as you provide the pertinent data the co e 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 you know recently in California most counties had at least four hundred and seventeen thousand max loan in that in some counties had as high as six hundred twenty-five thousand and up north and northern Cal for 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 user the first-time veteran use it this was recently two point one five percent of the loan amount and for repeat users as high as three point three percent.
Now let’s talk about the pros and cons of VA financing pros, because 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.
Now 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 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 over to qualify pretty amazing.
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 four and four together that’s a total of eight percent of the purchase price in seller concessions that can be given up very attractive for veterans to get into the home with with VA financing.
No cash reserves are needed the VA can be funded for widows of deceased veterans who never remarried veterans without credit scores or traditional credit can be eligible as well just like with FHA as we discussed earlier.
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 and finally veterans with service related disabilities ten percent disability can have their VA funding fee waived.
If they can document that and that means they’re not borrowing exactly 100 cent of the purchase price and nothing more cons what are some of the negatives in with regard to VA financing 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 non occupant Coll borrower whereas you can with FHA.
Now in community property States the spouses debts just like with FHA loans remain earlier has to be counted and can lower the buying power. The property is rigorously inspected by the VA appraiser. In fact some sellers tend to react unfavorably because of the stigma associated with VA loans for that reason and it takes a good skilled loan officer to get on the horn, get on the phone with the seller and/or the sellers agent and reassure them regarding VA financing, because quite honestly it’s really not that bad and a lot of the VA loans that we’ve been involved with have closed smoothly and quicker than even FHA or conventional financing. Finally obviously you have to be a veteran you know in active duty or reserves or tasks for God to be able to get a VA loan, it’s not for everyone.
Finally USDA loans let’s talk about USDA loans USDA loans are guaranteed by the US Department of Agriculture and they give the lender assurance that they will guarantee of the 90% of the amount of the loan in the event of default.
Now in response to this guaranteed by the USDA lenders will lend 100% of the purchase price and sometimes even more than 107 the purchase price, if the appraisal supports a higher value than the contract price between buyer and seller ,pretty amazing and this makes the USDA loan unique amongst the big four loans.
Let’s take a look at some of the pros of USDA financing 100% financing no money down flexible underwriting guidelines such as FHA. there is no loan amount limit. I don’t think you heard that there is no limit on the loan amount that’s an awesome thing and stands that apart from FHA and conventional financing there’s no limit on the loan amount the borrower is only limited by how much they can afford.
There is no cash reserves needed the seller can pay an unlimited amount in closing cost and less the amount being paid it’s abnormal for the area or for the market that homes in but again it’s not uncommon for USDA financing to involve you know seven or eight percent seller concessions lower credit scores typically six 20 years sometimes they even lower than that are accepted by lenders for USDA financing and even buys with no score and no traditional credit can be approved.
Now here’s a good one repairs can be financed in with the USDA purchase loan up to ten thousand dollars. now this enables a buyer to purchase a home that needs a little bit of renovation without having to come up with their own cash incredible thing so $10,000 is funded on of the loan and those funds are held in escrow or an escrow account for the work to be completed typically within 30 days of closing.
Now income from a second job can be used when you’re doing a USDA financing, used for qualifying purposes in if there’s a one-year history of it which is pretty special compared to FHA or conventional so if you’ve got a second job and you’ve got documental income from it on a USDA loan you can use that income with only a one-year history, and the last thing here we’re going to talk about under the category of pros is the mortgage insurance that’s now imposed on USDA loans as of October 2011 is to be declining with each passing year as the loan principal balance goes down, that that’s unique compared to FHA mortgage insurance the USDA mortgage insurance which is 0.3 percent per year.
The dollar amount is going to decline because it’s always based on the principal balance of the loan in that year cons negatives of USDA financing obviously only owner-occupied properties are eligible non occupant call borrowers are not allowed there are income limitations based on the number of persons in the household and the county that the property is being purchased in and be sure to look at some of our other more detailed USDA home by webinars available on the blog in the YouTube channel to get the nitty gritty details on that but there are income limitations.
There are also geographic restriction so only properties in eligible areas can be financed again check our YouTube channel and blog to understand how to read the USDA eligibility map and how to find out which areas are eligible and which are not. I should say this all 50 states have eligible areas for the USDA loan.
Now after the initial underwrite by the lender the USDA field office has to do a second brief mini underwrite of the file, before the conditional commitment can be issued and that’s what allows the file to go through the closing then sometimes not always this can result in slight delays and longer processing times and you should be aware of that.
Now unlike conventional loans in community property states the spouses debts need to be counted against the borrower just like FHA and VA loans. Bankruptcies need to be three years old whereas FHA and VA allow two years cooling-off period from a bankruptcy.