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Home Loans: Finding the Best Fit in a Relaxed Mortgage Market


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By Chris Birk

It seems the Great Thaw may be upon us. Credit score requirements have loosened in recent months, a sign that at least some mortgage lenders are starting to take a softer approach after years of tight lending. Nearly a third of all successful mortgage applications in August featured FICO scores below 700, according to mortgage technology behemoth Ellie Mae. In August 2012, only about 15 percent of green-lighted borrowers had a sub-700 score.

That surprising uptick may signal a promising shift for prospective homebuyers. But let's not call it a comeback quite yet. Plenty of consumers with and without great credit are still struggling to secure home financing. Before you start shopping for a home, it's important to get familiar with your credit reports and credit scores. You're entitled to your free credit reports, as mandated by the government, once a year from each of the three credit reporting agencies. There are tools on the market that allow you to check your credit score for free. (Credit.com offers a tool like this.) The score -- whether you get it for free or purchase it -- may not be identical to the credit score your lender will see, but it will give you a good range to work with when you apply for a mortgage.

The bottom line is some home loans are still generally easier to obtain than others. Here's a brief survey of the field.

Conventional Loans: Conventional home loans are "conventional" because they don't come with a government backing and generally conform to requirements set by Fannie Mae and Freddie Mac, the biggest purchasers of home loans issued by private lenders.

Conventional loans are traditionally tougher to obtain than government-backed mortgages, and that's still pretty much the case today. Conventional lenders are generally looking for a credit score of at least 740, which is higher than the typical minimum score required for government-backed loans. The average credit score for conventional borrowers in August was 758, according to the Ellie Mae report.

You'll typically need a down payment of at least 5 percent to secure a conventional loan. Usually anything shy of 20 percent will require the added expense of monthly mortgage insurance, which you'll pay until you reach a loan-to-value ratio of 80 percent. The exact amount will vary based on your down payment, your credit score and other factors, but 0.5 percent to 1 percent of the loan amount is a decent rule of thumb. Consumers with sterling credit and the assets necessary to put down 20 percent will often be hard-pressed to find a more competitive loan product than this one.

FHA Loans: The government doesn't make home loans. Rather, it insures them. Federal backing tends to mean less stringent requirements, and that's a big reason why loans guarantied by the government represented nearly half of all mortgages last year, as recorded by the Federal Reserve.

This loan program was created to help improve access to homeownership for lower-income buyers. FHA loans require only a 3.5 percent down payment, but they do come with both an upfront mortgage insurance premium and a monthly version, the latter of which you now pay for the life of the loan. That potentially decades-long expense is essentially the price for getting into a home today.

FHA lenders are considerably more forgiving to consumers with bruised and battered credit. Successful FHA homebuyers this August had an average 691 FICO score. The Ellie Mae report showed that applicants who failed to land an FHA loan had an average score of 667.

Previous homeowners who lost theirs to foreclosure also have a friend in FHA loans. The program recently altered its three-year "seasoning" policy to allow qualified homeowners to purchase just one year removed from a foreclosure. In comparison, some conventional borrowers may face a four- to seven-year wait.

VA Loans: The other major government-backed loan program is also booming. VA loan volume has more than tripled since 2007, and that's in no small way because of how difficult it's become for many veterans and service members to qualify for conventional financing. These loans don't require a down payment or private mortgage insurance. The minimum 620 credit score most VA lenders are looking for falls into a "Fair" score range, which is a step below "Good" (and that's a step below "Excellent").

VA borrowers without a service-connected disability pay a funding fee on both purchase and refinance loans. The fee is typically 2.15 percent of the loan amount and helps keep the self-funded program running. It's also a cost veterans are able to finance.

Perhaps surprisingly, in the face of all this flexibility, VA loans have had the lowest foreclosure rate out there for nearly all of the past five years. In some respects, VA loans are both the easiest and most difficult loans to land. Nine in 10 come with no down payment, and the typical VA borrower has less than $7,000 in assets.

But just becoming eligible for this program requires a level of service and sacrifice to which few Americans commit. Less than 1 percent of the population currently serves in the U.S. military.

More from Credit.com:
Why You Should Check Your Credit Before Buying a Home
How to Get Pre-Approved for a Mortgage
How Much of a Down Payment Do I Need?

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