The two most popular mortgage loan options are FHA loans and conventional loans. The basic difference between the two is that an FHA loan is insured by the Federal Housing Administration, and a conventional mortgage isn’t. Each has its own set of pros and cons, as well as different qualification requirements. So how do you know which type of loan is best for you and your unique circumstances? Find out by checking out this guide for home buyers in Redlands deciding between an FHA loan and conventional loans.
Differences Between an FHA Loan and Conventional Loans
When it comes to the differences between an FHA loan and conventional loans, here are the basics . . .
“An FHA loan is a home loan backed by the Federal Housing Administration, a government agency created to help home buyers qualify for a mortgage. The FHA provides mortgage insurance on loans made by FHA-approved lenders, protecting them from the risk of borrower default.”
“Conventional loans are the most common in the mortgage industry.” Typically, they are “funded by private financial lenders and then sold to government-sponsored enterprises like Fannie Mae and Freddie Mac.”
Also, with an FHA loan, you’ll have to pay for private mortgage insurance regardless of the amount of the down payment. But with conventional loans, you pay for private mortgage insurance only if the down payment is less than 20% of the purchase price.
Following is a breakdown of the key differences:
- Lower credit scores permitted
- More stringent property standards
- Higher down payment sometimes needed
- Higher credit score required (usually at least 620)
- Smaller down payments usually allowed
- “More liberal property standards”
Let’s dig a little deeper than into FHA loans (as opposed to conventional loans), especially with respect to benefits and who they are best suited for.
“An FHA loan offers more flexible credit qualifying guidelines than other loan types” because “the Federal Housing Administration (FHA)insures this type of loan. The FHA does not lend the money; rather they guarantee the loan. Since the government is backing the loan, a lender is able to offer a competitive interest rate, which can save borrowers money.”
This means, then, that for an FHA loan, you don’t have to worry so much about a lower credit score due to, say, some late payments or bankruptcy. According to FHA guidelines you need a credit score of only 580 “to qualify for maximum financing on an FHA loan. (A conventional loan, remember, would require a score of at least 620.)
Perhaps the biggest advantage of an FHA loan is that it typically requires only a 3.5% down payment. But you can also combine an FHA loan with a down payment assistance program and wind up paying just 0.5% down. And that down payment doesn’t have to come out your own pocket – you are allowed to use gift money for the down payment.
Further, there is no penalty for prepayment. So if you pay off the loan early, you won’t be charged a prepayment penalty as you would be with other types of loans.
An important consideration for lenders is your debt-to-income (DTI) ratio because it’s a good indicator of “how likely you are to have a hard time paying your bills.”
“To qualify for an FHA loan, you cannot spend more than half of your gross income on debt; that is, a DTI of 50% or more. In some cases, a person may qualify with such a DTI. In general, however, lenders will want to see your debt-to-income ratio be no greater than43%.”
The biggest drawback of an FHA loan is Upfront Mortgage Insurance Premium (UFMIP). You typically have to pay this upfront at closing, but it may also be rolled into the loan.
And, as we mentioned, FHA loans also require “payment of a monthly mortgage insurance premium (MIP)to protect the lender in case of default. In most cases MIP stays on for the life of the loan unless you put 10% down, then it’s a minimum of 11 years.”
What this ultimately means is that you’ll wind up paying more over the life of an FHA loan than you would with a conventional loan.
Conventional loans, or conventional mortgages, are not backed by any government body. They also make up about two-thirds of all home loans across the country. They are generally best suited for people who are able to save up a fairly large down payment.
The two types of conventional loans are conforming loans and non-conforming loans. “Conforming loans have terms and conditions that comply with guidelines dictated by FannieMae and Freddie Mac . . . These two companies purchase mortgage loans from lenders then package them into securities and sell them to investors.” Non-conforming loans, also known as jumbo loans, are above Fannie Mae’s and Freddie Mac’s maximum loan amount. “These loans are distributed on a smaller scale and have higher interest rates than regular conforming loans.”
Conventional loans also offer more flexibility with respect to the loan amount, not having the cap that FHA loans do. They don’t come with the same amount of provisions either, and you don’t have to pay for mortgage insurance if you pay at least 20% down.
If you have a fairly high credit score, say, 720 or better, a conventional loan is likely your best option. You’ll get a better rate than with an FHA loan, and with no mortgage insurance to pay for, you’ll pay much less over the life of the loan.
Consult Your Redlands Agent
No matter which type of loan you choose, you still have to find a home that meets your needs and is priced within your borrowing limits. An experienced local agent can be a great asset in that regard. Whether you get your financing via an FHA loan or one of the conventional loans, if you’re a home buyer in Redlands, be sure to contact us today at (951) 232-9704.