Choosing the correct home loan can be a daunting decision, especially for first-time homebuyers. Initially, the process will be very overwhelming, but with the right help you can find the perfect mortgage for you. Here are a few factors to keep in mind when deciding between a conventional mortgage and an FHA-backed loan.
The Differences Simply put, a conventional mortgage can include any home loan that is not backed by a federal agency. There are a number of options for conventional mortgages, both conventional fixed and adjustable rate mortgages are common. FHA loans are backed by the Federal Housing Administration, in which the mortgage lender is guaranteed repayment if the borrower defaults. Since the loans are guaranteed by the government, they are attractive to banks and come with more lenient requirements. However, there are a number of criteria the homebuyer must still meet.
• Conventional: Perhaps the biggest drawback of the conventional loan is the relatively rigorous approval process. Since you will be solely responsible for guaranteeing the loan, your credit history and credit score will play a large role in securing a conventional loan. Though conventional and FHA loans currently both provide historically low interest rates, homebuyers with stellar credit scores will see decreased interest rates.
• FHA: FHA-insured loans will be much less rigid, especially for those with poor or no credit history. You’ll probably need a credit score of at least 580 and be able to provide explanations for any past credit problems. However, underwriters can be very lenient, even for those who have gone through bankruptcy within the past two years or foreclosure within the last three years.
The Down Payment
Visit five different lenders and you’ll find five different requirements for your down payment. Again, the conventional loan requires more from the homebuyer upfront, but will provide long-term savings and greater flexibility over the life of the loan.
• Conventional: Currently, most mortgages will require a down payment anywhere from 5 to 20 percent. This is obviously a healthy chunk of change, but if you have a stable job and a good credit history, increasing your upfront payment will greatly reduce your long-term financial burden.
• FHA: Currently, FHA loans require only 3.5 to 5 percent down to close the loan. Aside from the obvious benefit of requiring less money upfront, the FHA allows the down payment to be a gift from a family member, a non-profit agency or from the government. Both of these will help you get into a house and begin building the equity in your home. However, the lower down payment brings other disadvantages, such as mortgage insurance.
• Conventional: With a 20 percent down payment, a conventional loan will not typically require mortgage insurance. If you put down 5 percent, you’ll most likely be required to pay mortgage insurance premiums (MIP) on the other 15 percent. However, the insurance premiums typically end after you reach certain equity in the home.
• FHA: Though the FHA backing your loan provides you with benefits that you would not normally receive, it also means a riskier loan for your lender, which means slightly higher insurance premiums. With FHA loans, the MIP is built into your payments over the life of the loan and with a 1.75 percent upfront payment at closing, as of June 2012. So, although you’ll be getting in your house for less upfront, you’ll have some additional costs to contend with while you’re in your home.
Other Things to Consider
• Be on the lookout for prepayment penalties
• Conventional mortgages offer greater flexibility for refinancing, though Streamlined FHA refinancing is fast and easy if you meet certain requirements.
There is no right answer when choosing a home mortgage, but you will want to comparison shop the best rates for both FHA and conventional mortgages. Before you start applying for a home loan, make sure to review a copy of your credit report and discuss all your options with a financial expert. Although you can currently find historically low rates and home prices, you’ll want to do your homework before you rush into a loan.
About the Author: Brian Russell is a freelance writer for New American Funding, a Fannie Mae Seller/Servicer, FHA Direct Endorsement — HUD Approved, and VA Automatic mortgage lender with over 400 employees. The mortgage lender is licensed in 21 states across the nation, and offers a variety of home loan options, including FHA, Conventional, VA, HARP 2 and Jumbo Loans.
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