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Down Payment requirements, Government vs conventional loans

November 24th, 2013 by [shareaholic app="share_buttons" id="27157108"]

A commonly asked question by many that don’t have 20% for a down payment is, “How much is needed for a down payment to buy a house and what is better, FHA, VA or a conventional loan?” Before you can just throw out a price quote and say you are going to get a conventional loan, there are many reasons an applicant can be denied financing for a conventional loan or a government product (FHA, USDA or a VA loan) is the route to go to obtain the financing to accomplish what your goals are.

There are advantages of when to use a conventional vs. a government product when buying a home or even refinancing a current loan.

Government loans

For FHA loans, it’s 3.5%  For conventional, it’s 5%.  There are exceptions to the rule.  Some being, VA loans, zero down, but you must be a veteran of the military.  There are some houses that are available for 3% down, but there are very few of these houses. For FHA loans, if the house was foreclosed on and is owned by HUD (a former FHA loan by the previous owner), then the house is a HUD home & qualifies for only $100 down payment. There are very few of these homes and the bidding is very competitive.  Not many people end up winning the bids when offers are submitted. That leaves the majority of financed houses for either conventional or FHA loans.

FHA Loans

FHA loans are very popular for not only first time buyers but for many others that for some reason or another they have an easier time to qualify and get approved with an FHA loan. FHA loan question involves down payment requirements. Many people want to know what the FHA loan down payment rules are for a particular state or zip code.  There’s a mistaken impression among some FHA mortgage loan applicants that FHA rules for down payments vary from state to state, but the truth is that FHA loan rules require a minimum down payment of 3.5% for new purchase loans. Your down payment can be as low as 3.5% of the purchase price, and most of your closing costs and fees can be included in the loan. Available on 1-4 unit properties. One source of the confusion on the down payment issue? Many borrowers find there are additional factors that affect the amount of the down payment. For example, those who do not qualify for the most competitive loan terms may not be able to get the lowest required down payment. Credit issues or other factors may affect the lender’s perception of your credit worthiness. That can affect the terms, rates and down payment you’re qualified for from that particular lender. Some FHA lenders may have higher down payment requirement based on certain items, such as individual credit scores of each borrower.  So the minimum 3.5% down payment isn’t a guarantee that you’ll be offered for buying a house.

The down payment requirements for an FHA loan are the same anywhere you go, a minimum of 3.5% as long as your middle credit score is 580 or higher. If your middle FICO score is 579 or lower, then plan on needing 10% down payment. There are some banks and lenders that will not even offer FHA loans if your middle credit score is below 620 or in some cases 580.  So to get an FHA loan when one has a lower score is a higher risk to HUD (FHA).  The ratio of borrowers that default on their loans increases as the scores decrease.  These rations make the risk to reward for lending for some banks not worth lending due to the default ratios amongst borrowers with lower Fico scores. So this is a motivating factor to keep your credit score higher so you have less money out of pocket in purchasing a house.

If you’ve had a bankruptcy or a foreclosure in your past, FHA is more lenient. Chapter 7 bankruptcies require 2 years from the date of discharge and on Chapter 13 bankruptcies 12 months of on time payments. Conventional loans require 3 years on a Chapter 7 bankruptcy.

A non-work related foreclosures or short sale requires 3 years for an FHA loan and conventional loans require 4 years for a maximum of 80% loan to value. It takes 7 years to be eligible for the maximum of 95% ltv financing if you’ve had a foreclosure in the past.

If the foreclosure took place due to a medical related issue or a death of a spouse or family member, then 2 years instead of 3 years may be granted if the extenuating circumstances make sense to the underwriter.

If  a short sale or Foreclosure or bankruptcy was caused by a loss in income from work related, then 12 months is all that is required.

Back to work FHA loans are for those that have had a loss of income from work related challenges and either had a foreclosure or a bankruptcy.

1.    Document a financial hardship that led to their derogatory credit, such as loss in employment or significant drop in borrower/co-borrower income;

2.    Demonstrated re-credit worthiness in the past 12 months via new or reestablished trade lines;

3.    Completed housing counseling from a HUD approved agency.

Here are the two most important factors taken into account when an FHA approved underwriter examines a borrower’s eligibility to purchase a home via FHA financing after an unintended economic event:

1.    The number one most important documentation required is proof that your household income had a decline by more than 20% for a period of at least 6 months prior to default. HUD defines household income as income of both the borrower and co-borrower on the previous mortgage that went into default. For example, based on the recent HUD mortgagee letter, if the spouse was not on the mortgage then their income is not required to be documented and proven.

2.    The second most important factor in determining eligibility is the re-establishment of positive on-time credit for at least 12 months after the bankruptcy and/or foreclosure. For instance, if a borrower had a bankruptcy, they must have at least 3 new trade lines (i.e. credit cards or installment loans) established with satisfactory payment history.

VA Loans:

Down payment requirements are none.  Wow, this is pretty nice. But this is limited to veterans on those who qualify for veteran benefits.

VA loans do require a funding fee (which is another name for mortgage insurance). This is included in the closing costs (often the loan amount is increased to pay for the funding fee). The funding fee can only be waived if the veteran has a disability of at least 10% or greater and has the paperwork to show the disability from service.

The property must be the primary residence of the borrower for a purchase transaction.  If you are doing a refinance of an existing VA loan, then the property can be either a 2nd home or an investment property.

If you’ve had a chapter 7 bankruptcy, you only need 1 year from the date of discharge for a new VA loan.

USDA Loans

USDA loans are similar to VA loans where you don’t need any down payment funds, only closing costs.  The catch 22. There is a funding fee, which acts just like mortgage insurance (which at the end of the day, that’s all it is).

The other catch 22, the property being financed can only be in a designated USDA zone (are). There are predetermined geographical areas (maps) that allow USDA loans to be funded.

The property must be the primary residence of the borrower.

Conventional loans

On a purchase transaction for a conventional loan, it can be for not just a home you plan to live in (primary residence), but also a 2nd home or an investment property.

If  a short sale is in the past, then 3 years is required to get a new FHA loan if it was not from a loss in income from work or from a medical issue.

Conventional loans require a down payment of 5%. When the loan to value is greater than 80% (80% of the purchase price or if refinancing and having owned the property 12 months or longer then the appraised value), you will be required to have mortgage insurance on the loan. This can be paid either by a monthly fee or it can be financed into the loan and not require a monthly payment.

If you are able to qualify for a conventional loan, this can be advantageous for your monthly payments.

Borrowers should not expect to be given the same terms or conditions on a loan they are getting financing for, whether it’s an FHA loan or a conventional loan as a another person get’s for their loan. Each person has a unique set of circumstances and the loan amount, credit score, type of loan, down payment, if the loan is a purchase, refinance or cash out, primary residence, 2nd home or investment property all make up both the interest rate and the cost to get the loan.

Each mortgage bank has a unique pricing for each loan scenario as well as guidelines (requirements for underwriting) and niche products they are offering each month.

Consumers don’t know which mortgage banks offer a niche product for their set of circumstances.
Almost all borrowers don’t even realize that each mortgage bank has a niche of products as well as there’s a difference in pricing based on the overall set of circumstances for your loan requirement.

This is where working with an experienced mortgage broker that understands the different lenders niches, borrowers requirements and has access to many different lenders and products to serve the clients better than the borrower going to one lender can ever offer them.

Ben Gerritsen is a a mortgage broker for , based in Salt Lake City, Utah. He’s licensed in Utah and Texas for residential mortgage loans. They have access to over 50 mortgage banks throughout the country. They have the ability to close loans fast and to also get tougher transactions completed.


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