People looking to buy a home, especially their first home, often think the process amounts to going to the bank and asking for mortgage money which they'll pay back over time. However, there are different types of loans available, each of which are better for people with different credit backgrounds, income, and so on.
In this post, we'll discuss the differences between FHA and HomeReady home loans.
FHA loans are mortgages insured by the Federal Housing Administration. They're popular among first-time home buyers because they allow customers with marginal credit scores to secure a mortgage with a relatively small down payment, and they have no income limits.
Anyone with a credit score of 580 or higher qualifies for the normal FHA loan, which requires a down payment of only 3.5% of the house's purchase price. However, the FHA technically requires no better than a 500 credit score to qualify; if your credit score is between 500 and 579, you need 10% of the price as a down payment.
Another detail mortgage companies pay attention to is debt-to-income ratio (DTI). Simply put, this is your monthly debt payments divided by your gross monthly income (ie. what you make before they take taxes out of your check). The normal DTI limit for FHA loans is 43%, although it can go as high as 50% if the additional risk can be justified.
Mortgage insurance is another cost of these loans. It's normal for borrowers to pay mortgage insurance when their down payments are less than 20% of the house price. FHA loans have an annual mortgage insurance premium and an upfront premium, based on your loan-to-value ratio (LTV). The LTV is simply the value of the loan compared to the purchase price. When you first buy the house, if you make a 10% down payment, the LTV starts at 90% and goes down over time.
The annual premium is charged as a monthly fee and wrapped into the mortgage payment, so you don't notice it as much. If your LTV is over 90%, you'll have these payments for the life of the loan. If it's 90% or less, you pay insurance for eleven years, unless the mortgage runs out sooner. (You can always pay 10% or more as a down payment, even if you're not required to do so.)
The upfront premium is equal to 1.75% of the loan amount. The bigger your down payment, the lower the upfront premium. For example, if you buy a $100,000 with a $10,000 down payment, the loan amount is $90,000, making the upfront premium $1,575. If you only make a $5,000 down payment, the loan is $95,000, and the upfront premium is $1,662.50.
HomeReady loans have slightly more stringent requirements than FHA loans, but tend to be a better deal for those who meet those requirements.
The minimum credit score for a HomeReady loan can be 620, although this partially depends on the details of your loan and your financial history. To be assured of qualifying and receiving the most competitive rates available, it should be above 680. In addition, some areas have income limits to qualify; in these areas, you must have an income below the neighborhood's median income, as determined by census data.
However, if you qualify, the financial requirements are easier to meet than with FHA loans. The down payment requirements, for example, may be as small as 3% of the purchase price, and your debt-to-income ratio can be as high as 50% without special justification needed.
Finally, HomeReady's private mortgage insurance only consists of monthly payments. There is no upfront fee. If your LTV is over 90%, the standard coverage requirements are reduced, which saves you money. And once your LTV drops to 80%, you can ask to have the mortgage insurance canceled (this happens automatically at 78%).
What's my best option?
It mostly comes down to your credit score. If you can qualify for HomeReady, especially with a 680 or higher credit score, the savings over FHA loans are substantial. If your credit is below 620 or your income is too high, you can't qualify for HomeReady, so you'll need to go with FHA or another option. In some edge cases, a person who qualifies for both may be better off with FHA, but that's unusual. Speak with a mortgage expert to hash out the finer details; if you're in the Washington, D.C. area, make First Savings Mortgage your advisor of choice.