Conventional vs. FHA Loans – Which is Right for You?
If you’re looking for a mortgage in order to purchase a new home, you have more options available than you might think. There are two main types of loans available – conventional financing and FHA financing, and both can help you get the best possible deal when buying a new home. While both are still mortgages, they are suited to different types of home buyers. Here’s a summary of conventional financing and FHA financing, and how each type of loan could suit different types of home buyers.
What is Conventional Financing?
Conventional financing is issued by a private mortgage lender, such as a bank. Typically, these lenders will require a larger down payment to secure the mortgage on a new home, but the speed at which a mortgage can be granted and a sale can be completed makes them an attractive option for most buyers.
Conventional loans can be insured, but if you choose this option, it’s typically done through a private insurance company. If you can make a large enough down payment (at least 20 percent), insurance may not be required at all, which could lower your monthly mortgage payments. However, you don’t need to put down 20 percent or more to qualify for conventional financing; some lenders will accept a down payment between three and five percent, though you will need to get private mortgage insurance in this instance.
Your credit score will need to be at least 620, with the best deals often offered to applicants with credit scores above 680. Additionally, most lenders will cap your debt-to-income ratio at 43-45 percent, meaning that if you have a higher debt ratio, you likely won’t qualify for conventional financing from most mortgage lenders.
Conventional financing is a good choice for home buyers who can make a larger down payment, and who have good credit scores. It’s also easier and faster to obtain than FHA financing if you qualify for it, as the only review required is from the lender or mortgage provider.
What is FHA Financing?
FHA financing is essentially a loan from the Federal Housing Administration, hence the name. These loans are insured by the FHA, but issued by private mortgage lenders. This means that the FHA assumes responsibility for the loan, even if the recipient defaults. FHA financing can also be granted through the US Department of Veteran’s Affairs (VA), or through the Department of Housing and Urban Development (HUD). This can be a huge help to veterans or lower-income families looking to buy their own homes.
Good candidates for FHA financing are usually first-time home buyers, buyers with lower incomes, or buyers with a recent history of bankruptcies and foreclosures (two years for bankruptcies and three years for foreclosures). FHA financing can be arranged on a down payment as low as 3.5 percent, and if you are approved for a loan of this kind, you can use money gifted to you to help meet the minimum down payment.
Home buyers who want to get FHA financing for their mortgage don’t have to have a debt-to-income ratio of 43 percent or less, nor do they need a stellar credit score; scores of as low as 500 can still qualify for FHA loans. This means that even if you have a higher amount of personal debt, such as from credit cards, it’s still possible to get a mortgage and buy a home.
Pros and Cons of Conventional Financing
Because conventional financing often requires a higher down payment, you can start building equity sooner as you will have a lower loan-to-value ratio. There are also fewer limits on how much you can borrow, though the amount the lender gives you will depend on their own assessment of your financial situation. A larger loan amount gives you more flexibility when looking for a new home, as you won’t be as restricted by cost – though a larger loan will mean larger payments, so keep that in mind. Don’t go over the amount that you think you can financially handle every month and have breathing room, even if the lender says you make enough.
If you can make a down payment of 20 percent or more, you may not have to purchase mortgage insurance. Conventional financing can also be used to purchase second homes or investment properties, such as apartments that will be rented out, whereas other forms of financing may not allow for this.
Conventional loans do have some disadvantages. If you have a low credit score and/or a bad credit history, including foreclosures or bankruptcies, you might not be approved for conventional financing, or end up with a very high interest rate, which can then affect your ability to pay down the mortgage quickly. Closing costs are also paid separately, as opposed to being included in the mortgage (as with FHA financing), and seller contributions (the amount a seller might put towards closing costs to encourage a sale) can be limited. For example, if the down payment you make is less than ten percent, seller contributions are limited to three percent of costs.
If your credit history is good and you have significant liquid assets with which to make a sizeable down payment, then conventional financing could be a good option for you. However, if you don’t meet the criteria that most private mortgage lenders set, then looking into FHA financing might be a better option.
Pros and Cons of FHA Financing
FHA financing can be a good choice for first-time home buyers, buyers who are unable to meet a minimum down payment of five percent, or buyers with a less-than-stellar credit history. If you have had a foreclosure or bankruptcy in the recent past, you may find it easier to qualify for FHA financing as opposed to conventional financing. Seller contributions to speed up the closing process can be as high as six percent if the buyer is approved for FHA financing. This is why FHA financing is often the first choice for a large number of home buyers – it’s easier to qualify for a loan and helps you get on the property ladder faster.
However, FHA financing may not be the right choice for every home buyer. They don’t always provide the amount of financing you might need, especially if you require a larger loan. In addition, unlike conventional financing, mortgage insurance is required for all FHA financing, regardless of the size of your down payment – and the premiums for this can be quite high. This insurance is also required for the entire life of the loan, even if you have paid down a certain amount of the mortgage and have achieved a favorable loan-to-value ratio. You may also find it difficult to get FHA financing if you are looking to buy a second property, though some exceptions exist, such as needing a second home due to having a large family or needing to relocate to a more reasonable commuting distance for work.
If you have a reasonably good credit score and enough savings to cover a down payment of at least five percent, you might find it easier to apply for conventional mortgage financing as opposed to FHA financing. Even if the interest rate is higher, you will have more flexibility with conventional financing.
While FHA financing requires two forms of approval – one from the government and one from the private lender – this makes the qualification process easier, and so this form of financing can be incredibly useful for a wide variety of home buyers
Conventional or FHA Financing: Making the Best Choice for Your Future
When it’s time for you to buy your new home, make sure to look at all of your options for financing. Some home buyers might benefit from a conventional loan because they have the assets with which to make a sizaeble down payment, while others will find that FHA loans are a better choice for them because they have a past foreclosure or don’t have enough savings to get a conventional loan. It’s important to shop around when looking for lenders, as different institutions could make different offers, and so you could end up with a better deal than if you had gone with the first lender who approved you for a mortgage.
Both conventional and FHA financing have their advantages and disadvantages, but the important thing to remember is that you have multiple options available to help you purchase the home of your dreams. By doing your research, you can ensure that you get the possible deal for you and your family.