With mortgage rates improving (Federal funds futures trading implied a 95 percent probability that the Fed's target rate would be lower than the current level after the May 2024, Federal Open Market Committee meeting), our brokers tell us that attention has returned to the various types of mortgages available. As Orion’s brokers know, the type of mortgage influences the rate, terms, qualification requirements, and ultimately the type of home your client can afford. Orion offers a wide variety of home loans, but FHA loans and conventional loans are two of the most common mortgages.

FHA loans are backed by the Federal Housing Administration (FHA, a government agency) and offered by FHA-approved lenders. These loans are generally easier to qualify for, with lower credit scores, than conventional loans and have smaller down payment requirements, as low as 3.5 percent. But your borrowers will owe mortgage insurance premiums (MIPs) for several years, in some cases as long as they have a loan balance. Unlike other types of insurance, mortgage insurance does not protect the borrower, it protects the lender if the borrower stops making payments.

An FHA applicant can qualify with a credit score as low as 500, though 580 is preferable (and many FHA-approved lenders won’t go below it). Those that do have more stringent bars for their down payment, debt-to-income (DTI) ratio, and housing expense ratio. Although FHA loans require a 3.5 percent down payment if the credit score is 580 or higher, those with scores below that, if the lender accepts them at all, usually must pay 10 percent down. FHA loans canbe used only to buy a principal residence.

Conventional loans are not insured or guaranteed by a federal agency and have stricter lending standards and larger down payment requirements than FHA loans. Orion’s brokers know that on the plus side, private mortgage insurance (PMI) is required only if your client puts down less than 20 percent. Your client can ask to cancel PMI when their balance drops to 80 percent of the home’s originalvalue (LTV). Typically, to qualify for a conventional loan, one generally needs a credit score of 620 or higher.

There are conventional programs that offer first-time homebuyers loans with a down payment of as little as 3 percent of the purchase price. To forego paying mortgage insurance, though, your client needs to put down 20 percent.

FHA and conventional programs look at Debt-to-Income (DTI) Ratios differently. Brokers will take the time to explain that the DTI ratio compares income with debts and is calculated by lenders looking to determine if a person can afford to buy ahome and take on a mortgage payment. To determine DTI, a brokers will explain to a client, “Add up all your fixed monthly expenses (rent or mortgage payment,minimum monthly credit card payments, student, auto, and other loan payments, and any other recurring fixed costs, such as homeowners’ association (HOA) fees and alimony). Then divide the total by your gross monthly income to come up with the DTI. For example, if you’re expenses are $2,000 per month and your income is $5,000 per month, your DTI would be 2/5, or 40 percent.”

This is important, since with an FHA loan, the DTI ratio can’t be higher than 45 percent if their credit score is below 580 in most scenarios. Most conventional and FHA mortgages require a DTI ratio of 50 percent or less. The DTI may also influence whether the loan is destined for a Qualified Mortgage (QM) or non-QM program.

The upfront fees on conventional loans (Fannie Mae and Freddie Mac) vary based on credit scores and down payments. The higher the down payment, the lower the fees, though it will still depend on credit score. Brokers know that FHA loans may also have additional closing costs that aren’t required by conventional loans.

Both types of loans limit how much one can borrow. For 2024, the FHA loan limit for one-unitis $498,257, $1,149,825 in high-cost county areas. Conventional loans are subject to limits set by the Federal Housing Finance Agency (FHFA). For 2024, that’s $766,550 for a single-family home in most of the United States.

There are many nuances embedded in each program, which is why borrowers are well served by going to a trained mortgage broker!

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