When refinancing you’ll be given the option to refinance through two types of lenders: FHA and conventional. FHA lenders are approved by the Federal housing Administration to give home loans using the FHA underwriting guidelines. The administration itself does not offer the loans, but instead it insures them. However, it does make sure that the loans being insured through the government program are approved using the proper guidelines. Conventional refinances are acquired through conventional lenders– which are simply lenders who follow the underwriting guidelines of Freddie Mac and Fannie Mae. These guidelines are a bit different than the federal guidelines; some may argue that they are less forgiving. When comparing FHA vs. conventional there are pros and cons to both, so here are some of those items you need to consider when refinancing.
Why People Choose FHA
After the economic recession hit around 2008 the number of federally insured mortgages began to climb….and climb some more. Today they make up a huge chunk of all approved real estate loans. Why? Because these lenders are able to work with homeowners who have experienced financial loss and breakdown.
Financially, the requirements for a federally insured loan to be approved (whether it is a first time loan or a refinance) are much less stringent than those for a conventional loan. The down payment is typically around 3.5% of the property value, which on a $200,000 house is around $7,000. But this down payment doesn’t have to come out of your pocket. In many cases the money can be gifted to you through a friend, an employer, a family member, or an organization that specializes in making these down payments to help people get on their feet.
Qualifying is Possible with Poor Credit
Perhaps the biggest reason FHA loans have jumped is because people can qualify for the loans and get a decent interest rate even if they have sub-par credit and a less than perfect financial history. Federally approved lenders are able to offer loans to people with a credit score as low as 500 points. However, they aren’t required to, so many of them may have the limit set higher than 500. Ideally the score will be a minimum of 620.
In terms of your financial and work history, it is a requirement that the person applying for the loan have a steady two year job history with pay that has remained the same or increased. The credit report must also reveal on-time payments on all of your debt over the last two years– with exceptions made for no more than two late payments that were more than 30 days late in that time period.
Recovering from a Bankruptcy or Foreclosure
As a result of the economic downfall many people found themselves jobless and facing foreclosure. Thousands of homes were foreclosed and thousands of homeowners took out bankruptcy. Typically this type of financial blow will be a black mark on the record for at least seven years. However, the requirements state that you can apply for a home after only a few years. With a foreclosure you need to wait three years before applying for a loan and two years after bankruptcy. If you use that time to rebuild your credit and financial history then you’ll be able to qualify for a loan in only two to three years. Many homeowners have chosen to do this and are finding themselves in homes that they didn’t think they would be in after such a short a period of time.
Why Conventional is Appealing
Conventional lenders are not able to offer as many of the financial perks to struggling homeowners as federally insured lenders can, but they are still worth utilizing for a refinance. Typically speaking, if you have good credit and a good financial history, conventional lenders will more than likely be a better option for you. The biggest reason for this is private mortgage insurance.
What is Private Mortgage Insurance?
With any loan, if you have less than 20% equity you are required to pay mortgage insurance. When you refinance or purchase from a conventional source you will pay a private mortgage insurance provider. However, if you utilize the services of a federal lender you will pay the mortgage insurance to the Federal Housing Administration. The biggest difference between the two is that the private mortgage insurance amount will be determined using your financial history including: credit score, credit report, and debt-to-income ratio. They will weigh the risk you are and then determine the amount. On the other hand, FHA loans require the same dollar amount for insurance no matter how great or poor your credit is, and the rates have risen over the last couple of years so the margin of profitability is shrinking. In addition to this, after you hit that 20% equity you can have the insurance removed from your mortgage. You can’t do this through FHA sources — the insurance you get on the loan is there for the life of the loan regardless of the equity you have in the property.
To put it in a nutshell; FHA loans are often more beneficial for homeowners who don’t have perfect finances or who are trying to repair their financial situation– this is the case whether you are getting a new loan or refinancing the loan you currently have. Conventional loans are often more effective for homeowners who don’t have issues with their finances. Conventional lenders are able to offer loans on second properties or for properties that cost more than the average price range. In reality, your financial situation is going to be the determining factor in whether you choose FHA or conventional.