VA and FHA Mortgages

Anyone tuned-in to the mortgage market knows that it's harder to get financing these days, unless you have premium credit ... or close ties to a loan officer.

All kidding aside, even though skittish lenders are seeking shelter from the subprime loan fallout they helped create, they're still selling loans. And plenty of people continue to shop for mortgages.

Existing-home sales reached a seasonally adjusted annual rate of 5 million units in July 2008, according to the National Association of Realtors. Though that's down from 5.76 million a year ago, the mortgage market cannot be declared dead yet.

Nevertheless, lenders are tightening underwriting standards, making it tougher to get a conventional fixed-rate or adjustable-rate loan.

Government loan programs, too, are getting sucked into the vortex of the subprime mess and are undergoing limited reform.

FHA loans, increasingly popular with first-time homebuyers, are going to be slightly harder to get due to the newly inked federal housing bill. And VA loans, possibly the most attractive of the bunch, are restricted to buyers who meet certain eligibility guidelines, such as satisfactory military service.

Picking out a mortgage suited to your needs can be confusing, especially if you qualify for more than one kind. Compare these three loan types before you go mortgage shopping.

Conventional loans

Conventional loans are "conforming" if they are generally $417,000 or less for a single-family home. Conforming loan limits can be higher in pricier regions of the country. For example, in such states as Alaska and Hawaii, it's $625,500.

There are also established guidelines for borrower credit scores, income requirements and minimum down payments. For example, most conventional loans require somewhere between 5 percent and 20 percent down.

"Right now those guidelines are changing frequently but they should have at least a 620 credit score," Councilman says. "Anything below a 740 credit score and they (lenders) are going to start adding fees which can be quite sizable, in the several-percent range, as borrowers' credit scores drop compared to loan-to-value (LTV)."

Conventional loans can be conforming or nonconforming. Loans above the lending limits set by Fannie Mae and Freddie Mac are called nonconforming or jumbo loans.

Most conventional mortgages have either fixed or adjustable interest rates. Typical fixed interest rate loans have a term of 15 or 30 years. A shorter-term loan usually results in a lower interest rate. Adjustable-rate mortgages, or ARMs, fluctuate in relation to the rate of a standard financial index, such as the LIBOR. Monthly payments can go up or down accordingly.

Cost: Origination fees, down payments, mortgage insurance, points and appraisal fees can mean the borrower has to show up at closing with a sizable sum of money out-of-pocket, or be prepared to roll over some of these costs into their mortgage amount, which may result in a higher loan rate.

Pros: Conventional mortgages generally pose fewer bureaucratic hurdles than FHA or VA mortgages, which may take longer to process because of the red tape. And because these mortgages generally require higher down payments than the others, home equity can build up faster.

Cons: You'll need excellent credit to qualify for the best interest rates. Also, many lenders require higher down payments than for government-backed loans. In declining markets such as this one, borrowers may only qualify for 90 percent loan-to-value and have to come up with the rest out of pocket. Some lenders may require as much as 20 percent down, particularly for condominiums in markets where it's difficult to get mortgage insurance.

Who they're good for: Conventional loans are ideal for borrowers with excellent credit who can afford a down payment of 5 percent or more.

---

VA loans

How they work: Consumers who served stints in the U.S. military or who are on active duty may want to look into a VA Home Loan administered by the U.S. Department of Veterans Affairs.

Qualified veterans can purchase a primary residence with no money down, as long as the purchase price doesn't exceed the appraised value of the property and the seller is willing to pay closing costs.

The VA does not loan money, but it does back loans made by private lenders to qualified veterans.

The veteran's basic entitlement under the loan program is capped at $144,000. But for the past several years, the VA has been guaranteeing up to 25 percent of the total loan amount based on the conforming loan limits allowed by Fannie Mae and Freddie Mac.

The conforming loan limit for 2008 is generally between $417,000 and $625,500, but depending on where the property is located in the U.S., can exceed those amounts.

"The VA guarantees the basic entitlement, but the veteran can still get a loan up to $417,000 with no money down and in some high-cost places it's up to $729,750," says Judith Caden, director of loan guaranty services for the U.S. Department of Veterans Affairs.

Veterans still need to qualify with respect to income and credit score, and may need money for closing costs. However, the VA program permits the seller to pay closing costs. Borrowers may also need money for the earnest deposit (money the seller usually requires to remove the property from the market while the sales contract is under negotiation).

Loan refinances are restricted under the VA Home Loan Program unless the borrower is refinancing from one VA loan to another.

"If they wanted to get do a cash-out refi, they would be limited to $144,000, or if they were trying to refinance from a conventional loan to a VA loan, they would be limited to $144,000," Caden says.

Service eligibility and entitlement guidelines can be tricky, so it's best to check with the VA before applying for a loan.

One important caveat: A dishonorable discharge will disqualify a veteran from the loan program. However, it's possible to make an appeal to change the status of the discharge.

Cost: Private mortgage insurance is not required, but the VA charges an upfront VA funding fee, which can be rolled into the loan or paid by the seller. The funding fee helps pay for the cost of a VA loan, reducing the cost to taxpayers. The fee can be as low as 0.5 percent for Interest Rate Reduction Refinancing Loans, which enable veterans to refinance an existing VA loan to one with a lower rate. And the funding fee can be as high as 3.3 percent for subsequent users of the VA home loan program.

For first time borrowers, the funding fee ranges from 2.15 percent for regular military to 2.4 percent for Reservists and National Guard borrowers. A down payment can result in a lower fee. For example, the funding fee for a member of the regular military who puts between 5 percent and 10 percent down will be reduced from 2.15 percent to 1.5 percent. For down payments greater than 10 percent, the fee goes down to 1.25 percent. For members of the Reserves or National Guard, the fee falls to 1.75 percent and 1.5 percent, respectively, in these cases.

Pros: With VA loans, borrowers can qualify for 100 percent financing of the sales price. Veterans do not have to be first-time buyers and may reuse their benefit. Private mortgage insurance is not required. The loans are assumable by another veteran provided he or she is qualified. Seller can pay closing costs and the VA funding fee as long as these expenses don't exceed 4 percent of the loan amount. Seller usually pays for the termite report.

Cons: The veteran must produce a Certificate of Eligibility, or COE. Borrowers may have to pay the VA funding fee, which can mean borrowers may end up with a 102 percent to 103 percent loan on the property. Borrowers must be creditworthy. The average FICO score for borrowers using the VA loan program is 680, according to Caden.

Also a surviving spouse must continue to make loan payments if the veteran dies before the loan is paid off. Veterans must have received an honorable discharge from the U.S. military. Medical and general discharges are handled on a case-by-case basis, but are generally approved.

Who they're good for: "VA is the best single program if you have no money down or little money down," Councilman says. "The veteran really doesn't need any money at all if the seller is willing to pay the closing costs."

---

FHA loans

How they work: The Federal Housing Administration, a part of the U.S. Department of Housing and Urban Development, or HUD, claims it has backed more than 35 million mortgages since its inception in 1934.

The FHA, like the VA, does not lend money. It provides government backing in the event that the borrower defaults on the loan. FHA loans can be fixed-rate or adjustable-rate mortgages, but the majority of loans are fixed-rate mortgages, according to the FHA.

"Right now, it's the fastest growing loan program out there," says Michael Ashley, chief business strategist with Lend America, in Melville, N.Y.

Ashley says that growth in the FHA loan program is being fueled by borrowers with newly adjusting ARMs looking to refinance into fixed-rate loans, as well as borrowers whose credit scores fall somewhere between excellent and subprime.

The FHA loan program has been revamped, at least temporarily, by new federal housing legislation signed into law in July 2008. Effective Oct. 1, 2008, changes include the following.

• Down payment gifting by the seller or any person/entity that financially benefits from the transaction will be prohibited.
• The minimum down payment will increase from 3 percent to 3.5 percent.
• The FHA may charge an upfront risk-based mortgage insurance premium, or MIP, of up to 3 percent. First-time homebuyers will pay no more than 2.75 percent. However, a 12-month moratorium beginning Oct. 1, 2008 caps the MIP at 1.75 percent.
• The new law temporarily raises the maximum loan limit for a single-family home to $625,500 ($729,750 or more in high-cost areas).
• It provides relief for borrowers wanting to refinance into an FHA-backed loan by allowing the lender to forgive all debt above 90 percent of the home's current appraised value. The borrower can then find another lender to refinance the remaining 90 percent into an FHA loan.

Borrowers have traditionally been able to get FHA loans with moderate to high debt-to-income ratios, or DTI. For example, many financial experts recommend your mortgage payment should not exceed 25 percent of your take-home pay. FHA loans enable borrowers to qualify for higher mortgage payments. Of course, a higher DTI means you commit more of your income to the mortgage payment and less to other needs.

"The standard without compensating factors is 31 percent to 43 percent (DTI), but it can go higher if based on compensating factors," Ashley says, referring to a good credit score.

One of the benefits of the FHA loan program is that many lenders are more willing to look at a borrower's overall credit picture rather than basing a loan decision on automated underwriting software alone. Such software generally incorporates a credit-score requirement.

"There are obviously justifications for people experiencing credit problems," says Christine Stanley, assistant vice president of mortgage underwriting at Vienna, Va.-based Navy Federal Credit Union.

"If you paint them all with the same brush, it gets a little more difficult to decide if somebody's at a 617 (credit score) because they are overextended or because they have a history of medical issues or job loss. We review them individually on their own worth," Stanley says.

Pros: FHA mortages require a low 3.5 percent down payment as opposed to conventional loans, which can require as much as 20 percent down. FHA has no stated minimum credit score requirement, but lenders may have their own guidelines.

Cons: Upfront mortgage insurance premium, or MIP, and ongoing annual premiums add to overall costs of a loan. The upfront MIP for delinquent mortgagors under the FHASecure loan program is 3 percent, at least until Sept. 30, 2009.

Who they're good for: The FHA loan program has historically been the "go to" product for borrowers with blemished or less-than-perfect credit, borrowers with moderate debt-to-income ratios and for those who don't have a lot of money for a down payment.