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What kind of mortgage is right for you?

by Scott Schang,

Taking out a mortgage to buy a home is the biggest financial commitment that most people will make in their lifetime.  Homebuyers entering the market today have witnessed years of fallout resulting from homebuyers and homeowners choosing the wrong mortgage, which in many cases ended in foreclosure and serious financial hardship.

Today’s homebuyer benefits from “knowing what we know now” and can rest easy that those toxic loans of the past are gone and no longer present a threat to your decision making process.

Active or honorably discharged members of the armed forces should always begin the mortgage process by researching their eligibility for the VA home loan benefit.

More information about VA eligibility can be found here – VA Home Loan Guaranty (hyperlink: )

For all other homebuyers the choice comes down to Conventional or FHA insured home mortgage financing.

Conventional or FHA – Which is Better?

The starting point for determining your mortgage options is getting pre-approved by a lender first and foremost.  In some cases, based on your financial profile, your mortgage chooses you – or more accurately, your options are limited or available based on your complete financial which can only be assessed through the loan approval process.

There are 3 main aspects of your financial profile that most influence what mortgage options are available to you.

Credit Score

When a lender looks at the credit scores of each borrower on a loan application, the qualifying score is the middle score of the lowest scoring borrower.  The minimum credit score required by most lenders will be 640 for both FHA and Conventional.

The cost of a FHA mortgage will increase slightly for borrowers with credit scores between 640 and 680, Conventional costs are nearly 5 times that of FHA up to 740 credit scores.  FHA may be a less expensive option if your credit score is under 740

Debt to Income Ratio

Both Conventional and FHA mortgages have a maximum allowable debt to income ratio (DTI) that determines the maximum mortgage payment you can afford.  Your debt to income ratio is the percentage of your gross monthly income required to pay your liabilities from your credit report as well as your proposed new housing expenses including payment, taxes and insurance.  FHA will allow a debt to income ratio as high as 57% while Conventional will only allow up to 45% as a general rule.

Down Payment / Assets

It is a common misconception that if you have less than a 20% down payment that you have to use FHA financing.  Conventional financing actually requires a lower down payment than FHA with a minimum 3% down payment compared to a minimum 3.5% required by FHA.

The biggest difference between the two mortgages is that Conventional will require a minimum 5% of the borrowers own funds be in the transaction (down payment and closing costs) while FHA does not have this requirement.  Conventional also requires that you have 2 months worth of payments in reserves.  FHA does not have a reserve requirement.

There are many more factors that are considered when qualifying for a mortgage, and the only way to know exactly what you qualify for is to get pre-approved by a lender.

In most cases you will qualify for both FHA and Conventional financing and there will be costs, advantages and disadvantages to each.  Ask your lender to compare the two options side by side so that you have all the information necessary to make an educated and informed decision.