Conventional Loan vs. FHA Loan
What is the difference Between a Conventional Loan and a FHA Loan?
There are many choices available when shopping for a mortgage loan, and the average first time home-buyer could easily become overwhelmed. It’s important to understand the differences between the two types of mortgage loans: Conventional and FHA (Federal Housing Authority), with four different factors to consider on either type of loan.
Your eligibility for either loan type is the very first thing to look at since your lack of eligibility may make other factors moot. Because the FHA guarantees a loan will be repaid to a mortgage lender, lenders have less risk in extending you credit. This leads to more lenient qualifications to being approved for a loan, with lower credit scores and down payments. Borrowers with scores of at least 580-600 who may not qualify for a conventional loan (typically needing scores of 620+), might be able to qualify for an FHA loan. In addition, a lower down payment is usually required with the FHA loans and borrowers with past foreclosures and bankruptcies can qualify for FHA loans within a shorter span of past years than with conventional loans. One other benefit of FHA loans is the allowance for a non-occupant, co-borrower’s income to be used in a blended ratio determining income to expense ratio in the loan approval process. Conventional does not allow this.
Typical Conventional loans offer a wide variety of fixed and adjustable rate programs. The most common FHA mortgage is a fixed 30-year loan since it’s easier for borrowers to budget for a specific monthly amount for a specified duration of time. There are FHA adjustable loans, but for either type of FHA loans, you still have to find a lender willing to offer such loans for specific credit scores. This will naturally limit the choices of what is available. Conventional loans are far more varied and are offered by many more lenders who can create choices based on your needs and credit factors. They have more freedom to adjust interest rates and lengths of terms, thus mitigating their risk while offering more customized loan packages.
General Loan Costs
There are many factors that contribute to the final cost of whatever type of loan you use. Both types of loan have specific cost pros and cons:
Mortgage insurance lowers risk for lenders in the event the borrower defaults on the loan. A mortgage insurance premium (1.5% paid at closing) is required for an FHA loan and can be rolled into the total loan amount. This insurance also must be renewed every year for the life of the loan at 0.5%. For conventional loans, the mortgage insurance premium can also be 1.5% at closing; however, it can be lowered or dropped with a higher down payment and credit score. Additionally, the premium can be canceled/refunded when the home-owners’ equity reaches a certain level.
Down payments are required for both types of loans, but the amount of cash required to put down on the same loan amount can be drastically different depending on the percentage required. A common FHA required down payment amount is 3-3.5%, as opposed to conventional loans that could require 5% and even up to 30%. While it’s always better to put down as high of a down payment as possible to lower monthly interest, insurance premiums and payments, many borrowers simply don’t have the cash to pay more. Low down payments make it possible for borrowers with less immediate funds to get a loan and pay a bit more over time.
Closing costs can be completely mitigated for an FHA loan. Borrowers are allowed to receive 100% of necessary closing fee funds from family, charitable organizations and government agencies. This includes the down payment, fees, and insurance, as well as all common costs. It’s possible for an FHA borrower to finish closing with no cash of their own. This is not typically true of conventional loans, which require certain percentages to come from the borrower.
Pre-payment penalty fees (outside of selling a home) are often required with conventional loans, whereas FHA loans have no penalties for paying off your loan early.
Only FHA loans are assumable. This means that when the homeowner with the FHA loan wants to sell, it may be possible to find an FHA qualifying buyer who can simply take over the loan. Since this could avoid all additional costs of a new loan, and only require a transfer fee, it could make selling the home far easier. This is never allowed with a conventional loan.
Regardless of which type of loan is best for you, as a home-buyer, the best thing you can do for yourself is to repair and then, maintain a healthy credit score and secure as large of a down payment as possible. The better your credit score and the larger the down payment, the more choices you have.
At Galaxy Lending Group, we are equipped with the experience and knowledge to make your home buying experience a smooth and pleasant one. We offer a credit assessment and offer our experience to help you be the best prepared for your home purchase! If you have any questions, you can speak to a representative of the Galaxy Lending Group at 602.595.1233.