What are FHA and Conventional Loans?
When looking for a home to purchase there are so many details to work out. The whole process can be quite stressful. One of the most fearful parts of the journey to home ownership can be the loan application. However, unless you plan on purchasing your home in cash you must tackle the loan application.
Recently William and I wrote a blog about the changes that FHA recently announced to its mortgage insurance premiums. In that one sentence are a few terms that probably need explained in more detail! So let’s go back to the beginning and start explaining!
FHA versus Conventional loans
- FHA loans are insured by a government agency, the Federal Housing Administration, and are offered by many lenders but not all. Because the FHA loan is backed by the government the qualifications to obtain the loan are lowered. In exchange the borrower MUST pay a mortgage insurance premium (MIP) to offset the risk.
- Conventional loans are not insured by any government agency. The lender still follows certain guidelines to establish who qualifies for a conventional loan. The criteria to obtain a conventional loan is more strict than for a FHA loan. With a 20% down payment there is no extra mortgage insurance premium required which is called Private Mortgage Insurance (PMI) for a conventional loan.
Who is eligible for a FHA loan? A Conventional loan?
- FHA loans have lower credit score requirements and lower down payment requirements. Currently FHA loans require a credit score of 580 to qualify for a 3.5% down payment. A credit score less than 580 would require a down payment of 10%.
- Conventional loans have stricter guidelines than FHA loans. A borrower must have a minimum credit score of 620 to qualify for a loan however a score of 720 or better will get you the best interest rate. A down payment of 20% is preferred. A lower down payment amount would mean the borrower must pay Private Mortgage Insurance (PMI).
In what instances would a borrower look at an FHA loan instead of a Conventional loan?
- Less cash for a down payment. Since a FHA loan requires only a 3.5% down payment a borrower who doesn’t have 20% to put down on a home FHA may be a good option. ALSO, with a FHA loan a borrower may use a “gift” of money as down payment.
- Less than optimum credit scores. If your credit is shaky you may still qualify for a FHA loan even with a score under 620. For a conventional loan a borrower must have a minimum credit score of 620 and higher to get the best interest rate.
- A recent bankruptcy, foreclosure, or short sale. With FHA’s Back to Work program a borrower can be eligible for a loan 12 months after being discharged from a bankruptcy due to an economic event (such as loss of a job). To qualify for a conventional loan 2-4 years must have passed depending on the type of bankruptcy, foreclosure or short sale.
What are the disadvantages to a FHA loan?
For many prospective home owners the only way to qualify for a home purchase is with a FHA loan. However there are some extra long term costs. Stay tuned for Monday’s blog and we’ll give you the rest of the story! Plus an explanation of how that recent change FHA just announced this month could be a good thing for your wallet.
Diane and William Kradel