- - Thursday, November 15, 2012

Whether you are a first-time buyer, a repeat buyer or a homeowner interested in refinancing, you’ll need to choose between conventional financing and an FHA-insured loan.

Contrary to what many think, FHA-insured loans are available to all borrowers, not just first-time buyers. These government-insured loans do not have income limitations, either. Every potential mortgage borrower should consult with a reliable mortgage lender to explore the pros and cons of various loan programs, but aspects of FHA loans make them appealing for some borrowers.

“Typically, if a borrower has a little more cash and can make a down payment of at least 5 percent and still have some cash reserves, a conventional loan will be a better fit,” said Patrick Cunningham, vice president of Home Savings and Trust Mortgage in Reston. “Usually, a conventional loan will be a little cheaper in terms of monthly payments.”

Scott Toler, president and CEO of the Credit Union Mortgage Association in Fairfax, said borrowers will make the cheapest monthly mortgage payments if they can make a down payment of 20 percent or more and can qualify for a conventional home loan because they won’t have to pay private mortgage insurance (PMI).

Borrowers who make a down payment of less than 20 percent or have less than 20 percent in home equity must pay private mortgage insurance (PMI) for a conventional loan. All FHA borrowers must pay annual mortgage insurance premiums for at least five years, as well as an upfront mortgage insurance premium. Mortgage insurance payments for borrowers depend on their individual circumstances.

“The biggest reason people choose an FHA loan over a conventional loan is that you only have to make a down payment of 3.5 percent on FHA loans,” said Gregg Busch, vice president of First Savings Mortgage Corp. in McLean. “However, conventional loans are now available to borrowers with a down payment of 3 percent if you have good credit.”

Many conventional lenders require a down payment of 5 percent or more. The rules about the source of down-payment money differ between FHA and conventional loans.

“FHA guidelines allow your down-payment funds to come entirely from a gift,” Mr. Cunningham said. “Buyers who are getting money from their parents or grandparents will often choose FHA financing because of that rule.”

Mr. Cunningham said the down-payment rules for conventional loans depend on the size of the down payment. If you are making a down payment of 5 percent, all of the funds must be your own. If you are making a down payment of 10 percent, 5 percent of the funds can be gift money. If you are making a down payment of 20 percent or more, all of the funds can be from a gift, he said.

In addition to needing cash for a down payment and closing costs, borrowers who choose conventional financing typically need to demonstrate that they have cash reserves to cover emergencies.

“FHA loans don’t have a specific guideline for cash reserves, but most conventional loans require at least two months or more of mortgage payments in the bank,” Mr. Cunningham said.

FHA loans are appealing to borrowers with less cash and also are a good fit for borrowers with less-than-perfect credit.

“Conventional loans usually require a credit score of at least 680, but most lenders will approve an FHA loan for borrowers with a credit score as low as 640,” Mr. Busch said. “Sometimes they’ll go as low as 620 if the borrower has other compensating factors, such as a good income, a strong job history and their own funds for the down payment.”

Conventional loans have risk-based pricing, which means the interest rates are higher for borrowers with a credit score lower than 740. FHA loans generally don’t require a higher interest rate for borrowers with a low credit score, often resulting in slightly lower interest rates than conventional loans for borrowers with low credit scores, Mr. Cunningham said.

Mr. Busch said FHA loans allow borrowers to have a debt-to-income ratio as high as 50 percent in some cases, while the ratio for conventional loans typically is capped at 42 percent, especially for borrowers who make a low down payment.

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