While it sounds like it should be a cut-and-dry answer, neither the conventional nor FHA requirements state you must be a first-time homebuyer. There are variations of these loans that do require that require at least one borrower complete a Home Education Counselling program (usually online) before closing on a purchase loan. It comes down to your down payment, credit score, assets (reserves) and debt-to-income ratio.
While the reputation is that FHA is for the first-time homebuyer, conventional loans can be just as good. The major difference between the two is the debt-to-income ratios. FHA was designed to have a higher tolerance to aide in more homeownership vs conventional has a lower tolerance.
What’s your Credit Score?
Let’s start with your credit score since that’s what lenders look at first. Conventional loan requirements have high credit score standards. To qualify for a low-down payment of 3%, which is lower than FHA requirements, you’ll need a middle credit score above 640.
If you have a lower credit score, you may have better luck with an FHA loan. The FHA requires for a similar low-down payment is only a 580 credit score, but you’ll need a slightly higher down payment of 3.5%. They take it a step further too – if you have a credit score between 550 – 579, you may still get approved but with a 10% down payment.
How Much is your Down Payment?
Speaking of down payments, this is important. How much you put down will determine which first-time home buyer program is right for you.
Both the FHA and conventional mortgage programs have low down payment options with only a 0.5% difference between them, but it comes down to your credit score. If you don’t have the good credit scores stated on the conventional loan requirements, you’ll need an FHA loan and a higher down payment of 3.5%.
Keep in mind too, if you have a large down payment of 20% or more, you can avoid Private Mortgage Insurance on a conventional mortgage since you only have to pay mortgage insurance until you owe less than 80% of the home’s value. FHA loans charge mortgage insurance for the life of the loan.
How Much Assets do I need?
Assets in simple terms are liquid financial instruments that you have access to. Like Cash, CD or Retirement accounts etc. To calculate the amount of cash that you will need to get approved for a mortgage is first by looking at the purchase price ie $100,000. The down payment is based on that number. i.e. $100,000 x 3%=$3,000. You will also have to have funds to pay for the closing costs which range from 2-5% (i.e. $100,000 x 5%=$5,000). You will also, depending on your credit score and the overall picture of you purchase and finances, need to have “Reserves.” Reserves is the backup monies you have saved up to pay the Principle+Interest+Insurance+Taxes in case you are out of work for a period of time. If you PITI was $500.00, then you should have a minimum of 2 months saved up somewhere $1,000.
How Much Debt do you Have?
The final requirement to determine which first-time home buyer program is right for you is to look at your debt-to-income ratio. This is a comparison of your total monthly debts (generally what shows up on your credit report not including items such utilities, water, trash and so on) to your gross monthly income (income before taxes). Calculating this comparison is called your Debt-to-Income Ratio (DTI).
The lower your debt is, the higher your chances of approval. The FHA requirements are more flexible than the conventional loan requirements, though. FHA loans allow borrowers to have a DTI of up to 50% in some cases as long as you have decent credit and stable income. Conventional loans require a lower DTI of 36% – 43% in most cases, making it harder to secure financing if you have a lot of debt.
The right program for first-time buyers is the one you can afford the most. There is such a slight difference in the down payment requirements for a conventional loan and FHA loan for a first-time home buyer, but the mortgage insurance and interest rates will differ.
Look at the bottom line for both loans. How much will it cost over the term, and can you afford the monthly payment? Looking at your financing options this way will help you make the right decision for your first home purchase!
Here at Unlimited Mortgage Lending, we strive to educate homebuyers. Our website is loaded with information and videos to help you understand the mortgage aspect of buying a home.
If you have any questions, please call, or email us, we would love to help you acquire your dream home.