Between conventional and FHA loans, more people can realize the American Dream of home ownership.
A conventional loan, or FHA? If you've got mortgage questions, these might be near the top of the list. Conventional is basically what it sounds like. It's the straight-arrow mortgage loan that more or less sets the bar for home lending. Sometimes that bar is difficult to meet, which is why other programs, such as FHA, exist.
Many experts say that if you meet the criteria, conventional is the way to go. While that's likely true, you shouldn't jump to any decision without knowing all of your options. Here's what you can expect with a conventional and an FHA home loan:
Conventional Loans Save You Money
Saving money might be a surprising reason to go with a conventional loan. Considering that other programs help make buying a house more affordable, it seems like the opposite would be true. It's not.
A conventional loan requires a higher down payment, which means that you finance less, pay interest on less, and with the right down payment, you'll also skip private mortgage insurance (PMI). PMI repays the lender if you default; it's not insurance that makes your payments for you. In the long run, you'll pay less for the house.
A conventional loan typically requires a higher credit score than FHA, and the NOLO legal information service says a downpayment of about 20 percent is typical.
While you can qualify for a conventional loan with a lower downpayment, you'll have to pay PMI. That means a downpayment on insurance upfront, plus monthly insurance payments until you meet the terms. PMI usually stops when your payments meet or exceed what you would have paid if you'd made the 20 percent downpayment from the outset, although some lenders will negotiate on when to drop PMI.
Conventional loans are available in conforming and non-conforming. A conforming loan has higher limits than FHA allows. Non-conforming loans fit outside those parameters. A non-conforming jumbo loan has a higher loan limit than a conforming loan. Non-conventional loans are also available for people with high debt or low income, but expect to pay for that in higher interest.
An FHA loan has a surprising bonus: If you want to sell, the next owner, even an adult child, could assume the existing mortgage.
FHA Loans Help More People Afford a Home
The U.S. Federal Housing Administration guarantees FHA loans. That means lenders face less risk if the borrower defaults on the loan, which means lenders can offer loans to more people.
You'll probably hear that FHA makes home ownership more affordable to a wider range of people. But that doesn't mean an FHA loan costs less. FHA can cost more than a conventional loan, just not up front. So more accurately, FHA helps more people acquire financing on a home.
The credit score requirement is lower than with a conventional loan. For scores under 600, FHA is a possibility. The downpayment requirement is much easier, too. Where conventional prefers 20 percent and will go as low as 5 percent, according to Money Under 30, the minimum FHA down payment is only 3.5 percent.
FHA also gives borrowers more freedom in downpayment and closing costs. As with affordability claims, you might hear that these loans offer low closing costs. That's not entirely accurate. What FHA offers is more flexibility with downpayment and closing costs, which can equal less out of pocket for the borrower.
Some or all of the 3.5 percent minimum downpayment can be paid by someone else, which isn't the case with a conventional loan. And an interested party, such as the seller, can pay some or all of the closing costs. One interesting perk with FHA loans is that under the right circumstances, they are assumable. That can make selling easier in the future.
Conventional and FHA loans both play important roles in the world of home ownership. If your credit is excellent and can afford the up-front costs, conventional is probably a long-term better deal. You'll get a better interest rate, and you'll pay less over the life of the loan.
With FHA, more people can make that critical step from renting to owning. With rents seemingly on a straight vertical rise, home ownership makes a lot of sense. Even with a higher interest rate and PMI, you can get the fixed-rate security of a payment that won't go up in 10 or even 20 years.
Looking for more information on buying the home of your dreams? Check out our purchase rates at eppraisal, and arm yourself with the knowledge that helps you make the right choice.