Before assuming a mortgage is unaffordable, potential homebuyers need to educate themselves on all the alternatives available to them, find out what they can qualify for, and then make the decision whether they can afford to buy a house. While the conventional, or traditional mortgage requirements can scare off first-time homebuyers, it is important to understand that there are other options available to certain groups that would normally not qualify for the traditional loans, such as non-conventional loans.
What is a Non-conventional Loan?
A non-conventional loan is a loan that offers more relaxed qualification requirements to encourage homeownership. These non-conventional loans are backed by different departments of the U.S. government, which means that the government protects the lender in the case that the borrower defaults on his loan. Because of the relaxed eligibility criteria, groups like first-time homebuyers, low-income earners, or even certain groups who have serviced the U.S. government in the past, can now get a mortgage through non-conventional loans. These requirements usually include a lower credit score and a lower initial down payment needed to qualify for the loan.
Types of Non-conventional Loans
The 3 most common types of non-conventional loans include FHA loans, VA loans, and USDA loans.
FHA Loans – are loans insured by the Federal Housing Administration in the U.S.. The FHA has a list of approved lenders, which are the ones that actually give out the loans, while the FHA only backs it up. This means that if the borrower defaults, FHA is the one to protect the lender. FHA loans have a minimum credit score requirement of 500 for a down payment of 10%, and a minimum credit score of 580 for a down payment of only 3.5%. Among other requirements, one worth mentioning is that through an FHA loan, the borrower has to pay mortgage insurance throughout the life of the loan in most cases.
VA Loans – are loans backed by the Veterans Affairs department of the U.S. government. These loans are only available to service members, veterans, or spouses of a military service member or veteran. VA loans do not have any credit score or downpayment requirements. Moreover, they do not require the borrower to pay mortgage insurance premiums. However, there is a down payment will have to be made if the appraised value of the home exceeds its market value. The down payment will equal the difference between the two. VA loans also require the borrower to pay a funding fee.
USDA Loans – are loans backed by the U.S. Department of Agriculture. These loans are made to encourage homeownership for individuals living in rural areas. To qualify for a USDA loan, the property must be located in a town of less than 20000 people. As in VA loans, there are no credit score or minimum down payment requirements. However, to qualify for a USDA loan, the income of the borrower must be less than 115% of the median county income. Also, mortgage insurance premiums will have to be paid throughout the life of the loan.
Conventional VS Non-conventional Loans
What is a conventional loan?
Conventional loans are not backed by the U.S. government. Instead, they are backed by private lenders. That is why borrowers pay private mortgage insurance on them. Conventional loans consist of two types of loans: conforming loans and non-conforming loans. The difference between the two is that conforming loans are under the limit set by the Federal Housing Finance Agency, and meet the necessary criteria to be purchased by Fannie Mae and Freddie Mac. Non-conforming loans exceed the FHFA limit and do not meet these criteria.
Differences between conventional and non-conventional loans
Credit score requirement – To even be considered for a conventional loan, your credit score must be at least 620. While non-conventional loans have a lower requirement of 500 for FHA loans and no credit score requirements for the other types (although VA borrowers usually have a credit score of at least 620).
Down payment – With conventional loans, borrowers can choose to put a down payment of only 3%. However, since this number is less than 20%, they will be required to pay private mortgage insurance. On the other hand, VA and USDA loans have no minimum down payment requirement at all, while FHA loans offer a minimum of 3.5%.
Interest rates – Even though conventional loans offer a lower down-payment than FHA loans, the interest rate, and mortgage insurance fees charged for the low down payment are considerably larger when compared to non-conventional loans.
Mortgage Insurance – This is an advantage of conventional loans since you only have to pay private mortgage insurance until you reach a loan to value ratio of 78% or if you choose to refinance your loan after you’ve built 20% home equity. Contrary, FHA loans require you to pay mortgage insurance throughout the life of the loan if you put less than 10% down payment, or pay insurance for 11 years if you put at least 10%. USDA loans also require mortgage insurance premiums to be paid throughout the life of the loan, while VA loans do not ask for mortgage insurance at all.
Loan Term – Non-conventional loans offer loan terms of normally 15 or 30 years, while conventional loans provide more options to borrowers with loan terms of 10, 15, 20, 25, and 30 years.
In conclusion, it is no wonder that many people nowadays find it difficult to built creditworthiness or save for a 20% down payment. With all the other living expenses people have to face, qualifying for a regular mortgage might seem impossible. However, it is important to explore all the options available such as non-conventional loans. With several alternatives to choose from offering different requirements, non-conventional mortgages have a solution for every person facing a unique financial struggle.