The Differences Between FHA and Conventional Loans

The Differences Between FHA and Conventional Loans

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Loan ApplicationThe Differences Between FHA and Conventional Loans

When taking out a mortgage to buy a home, you’ll have the option of using an FHA-insured loan or a conventional (regular) loan. The question is, which one is right for you? What are the main differences between FHA and conventional, and what are the pros and cons of each option? That’s the subject of today’s home buying tutorial.

Let’s start with some basic definitions and proceed from there:

FHA — An FHA loan is originated and funded by a lender in the private sector, just like its conventional counterpart. But it gets insured by the Federal Housing Administration, which is part of the Department of Housing and Urban Development (HUD). It is this government insurance backing that makes FHA loans different from conventional financing. Generally speaking, it’s easier to qualify for an FHA loan, and the down-payment requirement may be lower as well.

Conventional — This type of mortgage loan does not have any government insurance or backing. As a result, the down-payment requirement for conventional financing is generally higher than FHA. Most lenders will require a down payment of at least 5% for conventional, and some may require 10% or more. Additionally, the qualification criteria are generally stricter with these types of loans, compare to FHA.

In the FHA program, the government insures the lender, not the borrower. If the borrower / homeowner defaults on the loan, the lender will be insured up to the amount they funded (as long as the loan complies with HUD’s guidelines). But this insurance does not protect the borrower in any way. This is an important distinction, and also a common point of confusion.

Other Differences Between FHA and Conventional

Borrowers who don’t have a lot of money saved for the upfront costs of buying a home often choose the FHA program, because of the smaller down payment. Under current HUD guidelines, borrowers can make a down payment as low as 3.5% when using an FHA loan. Conventional mortgage financing typically requires more money down (though not always).

The qualification process is another key difference between FHA and conventional mortgage loans. In most cases, it’s easier to qualify for FHA due to the insurance backing. This makes the program appealing to borrowers with below-average credit scores, relatively high debt-to-income ratios, or other potential red flags.

You’ll recall from earlier that the federal government insures FHA loans against losses resulting from default. This gives the mortgage lender a level of protection they wouldn’t have when offering a conventional product. So they’re often more lenient when qualifying borrowers under the Federal Housing Administration’s loan program.

FHA loans are also eligible for “streamline” refinancing. This means you could refinance your mortgage down the road, with very little paperwork or hassle. Conventional refinancing typically requires more paperwork, home appraisals, and other hurdles.

As you can see, both of these loans have certain pros and cons associated with them. FHA allows for a smaller down payment and easier qualification (in most cases), but it requires additional insurance that will increase your monthly payments. With a conventional home loan, you could avoid the extra cost of mortgage insurance, but you would have to put more money down up front.

Choosing the Right Loan for You

So, how do you choose between an FHA or conventional mortgage? Think about your down payment, and your ability to qualify for a loan.

If you can afford to put 20% down, you might be better off using a conventional home loan, because you won’t have to pay for private mortgage insurance (PMI).

On the other hand, if you don’t have a lot of money saved up for a down payment, you might want to consider the FHA program since it allows you to put 3.5% down. Likewise, if you’re having trouble qualifying for a conventional loan, you might want to consider the FHA program.

As a borrower, you must thoroughly research both types of loans, and choose the one that best matches your financial situation.

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