One of the most important thing about buying a home is understanding your loan options. There are different types of home loans and depending on your credit score, that is what type of loan you will qualify for. Let's get into the different types to help you understand more about which one better suits your lifestyle and credit situation.
Conventional Loans:
Conventional loans are the most common type of home loans. You can purchase a home with as little as 3% down, but it could go as high as 20%. One of the most common misconceptions about this loan is the fact that first time home buyers don't qualify, but this isn't true. First time homebuyers can too qualify for this loan, but it depends on your personal credit situation.
Unlike FHA loans, Conventional home loans are offered by private lenders and aren't backed by the government. They're not insured by the government which requires you as the buyer to either put down 20% so private insurance isn't required or to acquire private mortgage insurance to cover the home.
Conventional loans can either be conforming or nonconforming. With a conforming conventional loan, the loan meets the Fannie Mae and Freddie Mac standards, while the nonconforming version is the total opposite. Conforming loans can't exceed conforming loan limits.
Nonconforming loans, commonly known as jumbo loans, are offered to buyers who wish to buy a home that exceeds the conforming loan limits. Just an FYI, conforming loan limits for 2023 have gone up to $726,200.
These loans are also offered at fixed interest rates or adjustable rate mortgages. The most common loan terms are 15 or 30 years, however some conventional loans are available for terms as short as 8 years.
Now what does your credit score have to be to obtain a conventional loan? Most lenders look at your FICO score to determine your credibility to secure a home loan. The average FICO score to secure a conventional home loan is 620 for an individual. This is your median score as an individual. If you have a co-borrower, they will average your scores based on both you all median score. For example, if your co-borrower's median score is 580 and yours is 720, they will average the two and make your median score 650.
As it relates to down payment, there's a big misconception that if you get a conventional loan you're required to pay 20% down. To qualify, you're required to pay between 3 - 5% down, but if you want to avoid having to pay for private mortgage insurance (PMI) and have them it worked into your loan, then you'll be required to pay the 20% down.
FHA Loans:
FHA loans allows you to buy a home with less strict financial and credit score requirements. You can get an FHA loan with 3.5% down and a credit score as low as 580. If your credit score falls below 580 (between 500 - 579), you will be required to pay a down payment of 10%. As you can see, the lower your credit score, the more money you're required to put down. Unlike conventional loans, FHA loans are backed by the government which means they're insured by Federal Housing Administration. This is the most common loan for those who have less than perfect credit. You can also have a higher DTI (debt-to-income) ratio.
These loans are nonconforming loans because they are backed by the government. This means borrowers don't have to meet the conventional loans lending standards. Just like conventional loans, these loans have the option of either fixed-rates or adjustable mortgage rates (ARMs).
The good thing about FHA loans is that the government is going to ensure the house is in tip-top shape and that it meets their standards. The last thing they want is for the home to be a money pit and have the borrower default on the loan because they're unable to maintain the home because it has issues.
FHA loan limit for 2023 is $472,030 on the low-cost counties. You can check the current loan limits for your county here.
As it relates to mortgage insurance, FHA loans require mortgage insurance premiums (MIP) which are worked into your loan and paid monthly with your mortgage payment. They add money to escrow and pay it through there. It's usually worked into your loan for the life of your loan unless you have paid a down payment of 10% or refinance yourself out of the FHA loan into a conventional loan.
USDA Loans:
USDA loans, often referred to as the "no down payment loan" are for those who want to buy homes in a rural or suburban area. Subject to household income restrictions. In order to qualify for a USDA home loan, the loan funds must serve as your primary residence. It can't be used for a farm, investment property, vacation home, second home or any income-producing purposes.
You can use the USDA home loan to purchase several types of homes as long as they meet the eligibility requirements. These homes include: new construction and resale homes, manufactured homes, short sales, condos, townhouses and foreclosure homes.
To find an eligible USDA approved area, you can check out the eligibility map.
VA Loans:
Last, but not least is VA loans which are exclusively for veterans and members of the armed forces and national guard and qualified spouses. You can also get this loan with zero down, if you qualify.
Contrary to popular belief, VA loans aren't issued by the Department of Veteran Affairs. VA loans are issued by a financial lender such as a bank, credit union or mortgage provider and it's backed by the federal government.
There are several different types of VA loans which include: VA purchase loans, VA Renovation Loan and Native American Direct Loan.
Let's get into what the different types of loans mean:
VA Purchase Loan is pretty self explanatory, but it is the standard form of mortgage loan issued under a VA loan. This loan allows buyers to purchase properties with $0 down payment. Remember, this varies as it relates to the borrowers personal situation. Borrowers may be required to make a down payment with a VA Jumbo Loan despite the Department of Veterans Affairs not requiring one.
VA Renovation Loan allows borrowers to use the funds to purchase and renovate a property. This loan finances the cost of the home improvements. It's similar to the traditional VA loan, but id designed to facilitate alterations to or repairs needed for the home.
Native American Direct Loan (NADL) is available for qualified service members and their surviving spouses who have a Native American descent. This loan program is backed by Department of Veterans Affairs and can be used to either purchase or refinance a home. Also requires no down payment.
Hope this helps you understand better of the different types of loan options you have as well as give you a better understanding of which type of loan you may qualify for before you start the pre approval process.
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