FHA Conventional vs Mortgages
Conventional vs FHA Mortgages
In the market for a mortgage? Then you might have come across the terms FHA loan and conventional loan. But what is the difference between these two terms?
The biggest difference between the two is conventional loans are not insured by the government and Federal Housing Administration (FHA) loans are. This key difference makes it possible for FHA lenders to offer low rates and more lenient requirements to borrowers that lenders of conventional loans cannot match.
Quite a few conventional loans, for example, insist that borrowers make a down payment of 20% or more. FHA loans, on the other hand, ask that borrowers make down payments as low as 3.5%.
Another huge advantage of FHA mortgages is that they are much more within reach of borrowers looking to get their first mortgage, especially those with imperfect credit histories.
The difference comes from the insurance that accompanies FHA loans, but not with conventional loans. Because FHA mortgages are insured by the government, lenders stand to lose little to no money if you default on your loan. This is why FHA loans come with much less strict requirements and lower down payments.
On the other hand, conventional loans are not insured by the government. If you, as a borrower, were to default on this kind of loan, the lender would be at risk of losing a lot of money. This explains why the requirements for conventional loans are stricter, credit scores must be higher, and down payments must be larger.
It’s no surprise then that FHA loans have become the loan type of choice for millions of mortgage seekers.
The FHA was created in the 1930s, when, in the midst of the Great Depression, the American housing industry was “flat on its back.” Its mission: To help average Americans become homeowners.
Since then, the FHA has carried out this mission by stabilizing the housing market and by increasing the availability of mortgage loans to as many people as possible. And their track record thus far is nothing short of impressive: They’ve insured upwards of 34 million home loans.
Your Choice: FHA or Conventional?
With these options in front of you, how do you know which mortgage type is right for you? It comes down to the pros and cons of conventional and FHA mortgages and how they fit your situation:
Reasons to Get an FHA Loan
- Low Down Payment. Nowadays, saving up thousands of dollars for a down payment is a challenge even for the most responsible potential homebuyers. If conventional loans were the only option in the marketplace, people unable to save up enough for a substantial down payment would be out of luck. And these are the potential borrowers the FHA is made to help.
- Gift Funds Okay. With conventional loans, you can use only your own money for a down payment. But for FHA loans, down payments can be paid using gift funds from family members. The one requirement is that the cash from your family or friends stay in your bank account for two months at least before the transaction occurs.
- Generous Credit Requirements. Similarly, with conventional loans, credit scores prevent many potential homebuyers from getting mortgage loans or at least mortgage loans with reasonable interest rates. This is another area where FHA mortgages come to the rescue. FHA loans take a much more well-rounded view of the borrower, considering not just the borrower’s credit score, but all of their circumstances. And they have much more flexibility in how they make their loan approval decisions.
- Money for Fixing the Property. Got a fixer-upper on your hands? FHA loans can include money for repairs. This makes FHA loans a much better choice than conventional loans if you’ve got your eye on less-than-perfect property.
- No Prepayment Penalty. With FHA loans, prepayment penalties are a rarity, which is perfect if you suddenly need to move and need to sell your new home.
- Lenders Everywhere. Thanks to the prevalence of the FHA program, finding an FHA-approved lender in any area of the country is easy.
- Loans Can Be Assumed. If you must sell a property that was financed with an FHA loan, you can streamline the process by simply transferring the FHA loan to a qualified buyer.
- Lenders Held Accountable. With FHA loans, lenders must be approved by the FHA and are held to the highest professional standards. This naturally protects you from having to deal with any shady lenders while obtaining an FHA loan.
- Lower Closing Costs. On a typical home loan, out-of-pocket costs can take you by surprise. But with FHA mortgages, lenders are obligated to keep closing costs "reasonable and customary," according to the market area. In addition, any other costs are usually paid by the lender or the seller, keeping your out-of-pocket costs as low as possible.
Reasons to Get a Conventional Loan
- Loans Available for More Property Types. Whereas FHA mortgages can only be used for first home purchases, conventional loans can be used for any kind of property purchase, like second homes, hotels, boarding houses, or bed-and-breakfasts. It’s worth noting here that, because FHA loans must be used for owner-occupied properties, you can actually use an FHA loan to purchase a multiplex property with up to four units, if you plan to occupy one of those units.
- No FHA Insurance Premium. Because they are government-insured, FHA loans come with a mortgage insurance premium, which is typically partly paid upfront and partly as an annual premium. These premiums increase the effective interest rate on FHA loans. It’s worth noting here that conventional loans see these same increases if the home buyer puts down less than 20%.
- More Innovative Loan Products. With conventional loans, you get more varieties of loans, including special, more innovative types of financing that just can’t get with FHA loans. This can be perfect if you’re an investor looking for short-term financing and have a stomach for less-forgiving terms.
- Lower Costs for Some Borrowers. If you have enough cash saved for a solid down payment and a great credit score, conventional mortgages can mean much lower costs for you.
- Faster Loan Process. Because they don’t require government approval, conventional lenders are often able to move more quickly to complete loan transactions. As mentioned above, FHA loans are subject to more requirements and those can slow things down.
- Avoid Escrow Account for Taxes and Insurance. FHA loans can increase your monthly mortgage payment because of the additional money the FHA requires be set aside in an escrow account for taxes and insurance. These funds are placed in an escrow account and added to your monthly payments until those costs and paid off. With a large enough down payment on a conventional loan, you’re more likely to avoid these extra costs.
Making the Right Choice for You
As you take on the challenge of choosing the right loan type for you, a systematic approach can simplify things. Start by carefully reviewing your financial standing, being sure to take into consideration any changes coming up in your future and all financial obligations you’re currently under.
Then, be sure to run through your monthly budget and decide how much of a monthly payment you can realistically afford. This is also the time to figure out how much you can provide for a down payment.
At this point, it’s time to get in touch with a Mortgage Advisor in your area to get their advice on your individual situation, especially in light of any recent changes in mortgage program guidelines.
Want to see if you qualify for a conventional or FHA mortgage loan? Contact a Mortgage Advisor today.