Buying a home– especially if it is your first time– can be one of the most exciting times of your life. It can also be one of the most nerve-wracking times. Especially if you are unfamiliar with the process, it can seem a bit overwhelming. Buying your first home can be a learning experience, and it is important to familiarize yourself with all the different options, fees, loans and other aspects that can help you get the most out of the experience. You will have this home and the loan that comes with it for many years, so you need to understand as much as possible about your options to make sure you get it right.
One of the most common questions about new mortgages deals with the different types of loans available. That is: What is the difference between an FHA loan and a conventional loan? While both loans are generally available from the same lenders, there are many differences between them. They both come from lenders in the private sector, but the biggest difference is that FHA loans are insured by the government, whereas conventional loans have no guarantee for the lender.
It is important to understand that this insures the lender (usually a bank or mortgage institution) not the borrower. This means that if you are unable to pay your mortgage and default on your FHA loan, the government will recoup the losses for the lending institution. With a conventional loan, there is no guarantee of default repayment included within the loan. Because of this, many lenders will require private mortgage insurance (PMI) to be paid along with a conventional loan if the down payment is less than a certain amount– usually 20 percent.
While the insurance aspect of the two loans is the biggest difference between them, there are several other aspects of the two that are different. They both have their pros and cons, and it is important for a home buyer to understand all the differences between the two in deciding which loan is best for their individual needs. In order to give you a general understanding of the two, we will go over the basic aspects of each, focusing upon where they differ.
These are the standard mortgage loans that banks and other lenders have given to homeowners for decades. Unlike FHA loans, they have no included insurance or guarantee for the lender if the borrower defaults, so the qualifications and requirements are usually stricter. Just like any other type of loan, the requirements, rates and down payment amounts will vary according to the lender. However, here are a few of the basic guidelines that are the most common in the mortgage industry.
Because there is no guarantee for the lender, the credit and financial qualifications will be stricter. Conventional loans require the borrower to have good credit, a steady income and be able to afford the down payment. Other requirements will be more specific per the policies of individual lenders.
Conventional loans also require significantly higher down payments than FHA loans. Most commonly, lenders require 20 percent of the total purchase amount, but it may go lower depending upon your qualifications and the requirements of the lender.
Conventional loans are not guaranteed by the government if the borrower defaults on the loan. Because of this, if you pay less than 20 percent down, most lenders will require the borrower to carry private mortgage insurance. Some lenders allow this PMI to be dropped once the home has reached a certain amount of equity.
Loan Types and Limits
Lenders have more flexibility in offering shorter or longer terms, adjustable rates and other differences with conventional loans. There is generally no limit for conventional loan amounts.
The Federal Housing Administration is a federal institution that provides insurance to mortgage lenders if a borrower defaults on an FHA loan. The government does not provide the loan, so FHA mortgages are still loaned by the same institutions in the private sector as conventional loans. However, this guarantee of default repayment allows for looser requirements and lower down payments.
FHA loans have lower standards of qualification than conventional loans. Individuals with credit within the 500’s can even qualify for these loans, but the lender still sets their own requirements.
FHA loans require lower down payments than conventional loans. Most lenders require as little as 3 percent or up to 5 percent of the total cost. Also unlike conventional loans, the entire down payment amount can be a “gift” from a family member or institution.
The Federal Housing Administration provides insurance for FHA loans. A large amount of the insurance premium will be required at closing, and the premiums will be included in your monthly payment throughout the length of the mortgage.
Loan Types and Limits
FHA loans are generally 30-year fixed rate mortgages. There is also a limit set on how much can be loaned depending upon the area. This means that areas with higher average real estate prices will have higher FHA loan limits.