When starting a search for a new home, one of the early considerations is deciding which type of mortgage to apply for. The best place to get started is to contact a trusted lender who can guide you through the application process and recommend which type of loan would be best for your financial situation. By way of preparation, we’ll delve into the differences between the two of the most common types of mortgage loans, conventional loans and FHA loans, as well as the benefits and drawbacks of each.
What Is a Conventional Loan?
A conventional loan means the mortgage is not backed by a government agency. They are originated and managed by private lenders like Financial Concepts Mortgage, as well as banks and credit unions. As such, these loans can be more difficult for potential homebuyers to qualify for because the lending institution will want to make sure that you are a good credit risk — that is, someone to whom they want to lend this large chunk of money.
Conventional Loan: Benefits and Requirements
Though they can be harder to get, a conventional loan can offer lower interest rates than an FHA loan, which can translate to a lower monthly mortgage payment. This is in part because a conventional loan usually requires you to put down a larger down payment (generally 20%) than with an FHA loan, and requires a better creditworthiness picture.
Approval for a conventional loan with a lower down payment — even as little as 3% down — is possible if you have good credit and don’t carry a lot of debt. However, a smaller down payment may prompt your lending institution to require you to carry private mortgage insurance (PMI), which can add to the cost of your mortgage.
Unlike FHA loans, which are strictly to be used in purchasing a property, a conventional loan may also allow you to include funds that will go toward home renovation, home improvement, or even furniture. While you still have to pay interest on these items, you won’t have to spend the time saving up for these expenses and can fund them at the time of purchasing your house.
As FHA loans are backed by the government, their inspections and appraisal process may be more stringent than what is required for a conventional loan. If you buy a house that needs some work or has some issues you plan to solve, it might not be possible for it to pass the required inspection by an FHA inspector, or it may appraise below the purchase price, and your loan won’t get approved. So, a conventional loan is better for these types of properties.
To recap, conventional loans offer many benefits for those who qualify:
- Less paperwork, quicker approval
- Lower interest rates (and thus a lower mortgage payment)
- Can avoid PMI with enough money down and good credit
- Home improvement/furnishing/landscaping costs can be rolled into the loan
- Easier to pass inspection
What Is an FHA Loan?
An FHA loan is one that’s backed by the Federal Housing Administration. This means that if the homeowner defaults on the loan, lenders are protected financially by the government. Congress created the FHA in 1934 in an attempt to make it easier for Americans to get into homeownership. At the time, only four out of 10 households were homeowners, and it was difficult to get a mortgage loan. FHA loans are designed to help low- or moderate-income borrowers, as well as folks who otherwise may not qualify for a conventional mortgage, to purchase homes.
FHA Loan Benefits and Requirements
One of the biggest benefits of an FHA loan for most Americans is that it requires a lower down payment than a conventional loan. Particularly if you have been a renter most of your life, it can be very hard to save up a large chunk of money to put toward a down payment. With FHA loans, you can borrow up to 96.5% of the home’s value.
You may also qualify for an FHA loan if you don’t have a perfect credit history, or don’t have sufficient credit history built up to qualify for a conventional loan. If your credit score is low, you will likely need to put more money down upfront.
FHA loans still require a detailed approval process, and lenders will look hard at your income history and other financial details to decide if you qualify and may require additional closing costs. Further, FHA home loan inspectors also have more stringent standards for potential problems with a given property — the government doesn’t want to back a mortgage on a house that has serious issues. And unlike conventional loans, an FHA mortgage is just for the property, meaning no funds can be rolled in for things like home repairs or landscaping.
FHA loan recap:
- Below-average down payment (usually a minimum of 3.5%)
- Less-than-perfect credit score/credit history accepted
- Can get approval even if you carry considerable debt
- Mortgage insurance may be more affordable
- May have to pay more in closing costs
Which Type of Loan is Right for You – Conventional or FHA?
Understanding whether you qualify for a conventional loan or would rather apply for an FHA loan is a complex question. The answer includes details like your income and income history, your debt-to-income ratio, the type of property you wish to purchase, and even where the home is located.
If you are in Oklahoma, Texas, Kansas, Arkansas, or Alabama, contact Financial Concepts Mortgage to get the application process started by calling 405-722-5626 or emailing us at firstname.lastname@example.org. We offer free consultations and will walk you through all available loan options to find the best option to get you into a new home.