Differences Between FHA and Conventional Mortgages
Across the land the vast majority of home buyers use either a FHA or a conventional mortgage to purchase a property. While these loans are similar in a few ways, there are some pronounced differences. Each one has benefits that cater to a particular group of buyers. Understanding how they are different and which one is best suited to different circumstances will help buyers feel more informed about their financial situation.
FHA stands for Federal Housing Authority. This agency does not make the loan itself. Instead, they insure FHA loans that are offered by approved mortgage lenders. The lender is protected in the event the borrower does not repay the loan.
FHA is committed to providing basic, conservative loans. A large number of their deals are fixed rate loans even though FHA does allow for adjustable rate mortgages.
A loan that is not insured by FHA is most likely a conventional mortgage. Mortgage brokers, banks, and credit unions offer a wide variety of conventional loans. Conventional loans have more unique offerings such as interest only type of deal or a combination of a first and second mortgage used for a purchase.
One of the major differences among the two types of loans is the requirement for a down payment. FHA will allow buyers to pay 3.5% of the home’s price as a down payment. The money used for the down payment may come from cash on hand, savings, retirement accounts or even a gift from a relative.
For conventional loans, the normal down payment is 20% of the home’s value. However, there are quite a few loans that will allow a 10% or 5% down payment. The money used for the down payment must come from the borrowers own funds such as savings, investments or retirement accounts.
Private Mortgage Insurance
Both the FHA loan and conventional loan requires private mortgage insurance (PMI) if the buyer makes a down payment that is less than 20% of the purchase price. This insurance is designed to protect the lender if the loan is not repaid in full.
With a conventional loan, the PMI will be in place until the loan balance is paid down to 80% of the home’s value. Typically, the PMI amounts for a conventional loan are higher than a FHA loan.
For an FHA loan, there is a fee charged at the time of the loan closing as well as a monthly amount paid with the loan payments. The monthly amount is enforced until the loan amount reaches 78% of the home’s value.
Credit Score Requirements
Conventional loans have usually been reserved for customers with the highest credit scores. Due to the problems faced by the mortgage industry over the past several years, this fact is even more true today. Conventional loans rely heavily on standard credit reports offered by the major credit bureaus. Most conventional mortgages are approved by a computer system and reviewed by underwriters.
On the other hand, FHA loans will allow a slightly lower credit score. In addition, FHA will allow underwriters to go beyond the computer system and make approvals based on a borrower’s complete file. Items like residence history, rental history and stable job history can persuade some FHA lenders to approve a loan for people who have scores that are slightly less than perfect.