When it comes to financing your new home, there are many different options available. Below I have outlined some of the basic differences in Conventional and FHA loans to show the pros and cons of each.
What is an FHA loan?
An FHA loan is one that offers mortgage insurance on loans that are made by FHA approved lenders. FHA stands for Federal Housing Administration and was created in 1934 by the US Congress. It is the largest mortgage insurer in the world and the only government agency functioning that does not use taxpayers’ money. The FHA insures the loan in order to minimize the financial risk to the lender. The FHA mortgage insurance provides protection to the lender against any losses and pays if a homeowner fails to pay their loan.
Are there pros or advantages to having an FHA loan?
The main advantage of an FHA loan is that you don’t need a large down payment, which can be as low as 3.5% of the purchase price. Other traditional loans require a higher down payment, so an FHA loan makes it easier for first-time home buyers or those who don’t have a large amount for a down payment to buy a house.
Another advantage is that you don’t need perfect credit to quality for an FHA loan. In fact, even if you have been denied for a conventional loan due to bankruptcy or foreclosure, you might still qualify for an FHA loan. The main requirements for eligibility are a valid social security number and US residency. There are other requirements that may vary from lender to lender, such as minimum credit score requirements, but they are generally lower than with a conventional loan.
Are there cons or disadvantages with an FHA loan?
The biggest disadvantage is that you will have to pay for the mortgage insurance premium (MIP). There are two premiums required on FHA loans: the upfront premium (1.75%) which can be financed into the loan amount, and the annual MIP, which is paid monthly, and could add from $50 to $150 to your monthly payment, depending on the value of your home.
Another factor that could be considered a disadvantage is that you will end up paying more interest since you finance a larger portion of the purchase price than with a conventional loan.
What is a Conventional loan?
A conventional loan is one that is made entirely in the private sector, without government insurance, assistance or approval. You can obtain a conventional mortgage loan from a variety of lenders, including banks and mortgage companies. The minimum requirements and qualifications will vary from lender to lender, as will the types of loan programs.
Are there pros or advantages to having a conventional loan?
The primary advantage of a conventional loan is that you are able to avoid the added expense of paying for mortgage insurance if you are able to make a 20% or more down payment. If you do make a lower down payment, such as 10%, you will be required to pay monthly insurance premiums. However, once your equity value reaches a certain value, you may be able to cancel the mortgage insurance, which would lower your monthly payment.
Another advantage of a conventional loan is that you will pay less interest over the life of the loan. Because you are required to make a larger down payment than with an FHA loan, you are financing a smaller percentage of the purchase price, thus saving you money in the long run.
Are there cons or disadvantages with a Conventional loan?
The main disadvantage with a conventional loan is the requirement of a larger down payment. Most lenders require 5% as the minimum, which is a little more difficult for potential home buyers. A conventional loan will also have stricter requirements for credit history, credit score, income and other factors, making it harder to qualify.
Which loan should I choose?
The answer will depend on a few things. FHA loans are usually the easiest loans to qualify for, and you don’t need as large of a down payment. Conventional loans can save you money both on the monthly payment as well as over the life of the loan, but require a larger amount up front. The best loan for you will be the one that fits your financial situation, budget and goals the best.
If you are considering purchasing a home, inventory is near the seasonal summer highs over the last three years. It is prudent to have a buying strategy in place with your financing approved and a plan to move forward quickly when you find the right home. If you want to talk about a buying or selling strategy give me a call at 214-642-1375 or click here.