The old argument about which is better, a Conventional loan or an FHA loan? This comparison has been around since time immemorial and still holds its grain today. The only right answer to this question is: it depends on the borrower’s situation as far as credit, income, and assets when buying a home. Here are some determining factors involve:
Interest Rate: The interest rate for both conventional and FHA rates can either be fixed or adjustable. Generally speaking, the conventional rate is higher, and FHA rate is lower than their conventional counterpart. The main reason for the difference in rate structure is the federal government insures FHA, and conventional conforming loans are obtained through private lenders or enterprise.
Credit qualification requirement is more lenient on FHA loans. Certain lenders will extend a loan to a borrower with a credit of 600 middle score. Finding a lender that will extend the same borrower a conventional loan is almost non-existent. If they do, it is almost always that the borrower is required to come up with a substantial amount of money to put down.
Mortgage Insurance is another issue if the borrower is not coming up with 20% down payment on these lower credit score borrowers. Conventional conforming loans require Private Mortgage Insurance (PMI). The PMI companies require borrowers to have a higher credit middle score, making it nearly impossible to get mortgage insurance on conventional loans with this type of borrower.
FHA loans do not have these criteria in qualifying borrowers. The Mortgage Insurance Premium (MIP) on FHA loan is more expensive in the long run, but it is paid up front, included in the loan amount and monthly payment. It does not have a credit qualifying requirement. The mortgage insurance premium for FHA loans do not and cannot be canceled regardless of the loan-to-value. The only way to cancel mortgage insurance on an FHA loan is to refinance it to another type of loan (e.g. conventional, VA, etc.).
Down payment requirement is where the two types of loan differ substantially. FHA only requires a minimum of 3.5% down payment. The total down payment can also be a “gift” from any immediate family member. On the other hand, conventional loans require a minimum of 5% down. Gift funds can only be used after the borrower comes up with the minimum 5% down payment requirement. If the total down payment on a conventional loan is at least 20% or more, the whole amount can be gifted.
Seller’s Concession is another area where there is a huge difference between the two programs. FHA allows up to 6% of the Sales price. The Seller can contribute up to 6% towards the borrower’s closing costs. Compare that to conventional loans, which only allow 3%, a borrower utilizing FHA loan program goes to closing bringing less money to the table.
Pros and Cons: A Summary
Most lenders would rather offer conventional conforming loans to borrowers over FHA. The fundamental reason behind this is: conventional loans are easier to process. Everything else being equal, it is simpler to qualify for FHA over a conventional loan. FHA’s credit requirement is lenient compared to conventional loans. Down payment requirement is less on FHA loans. With the 3.5% down payment and up to 6% seller’s concession allowed, you can see why FHA has increased in popularity among home buyers.
Conventional vs. FHA loans, which one suits your needs the best right now? For more information and a confidential analysis of your situation, contact our Home Loan Specialists at (281) 860-2533.