The amount of Americans who can’t currently afford the homes they live in has risen by 146% in the past few years.
You’ve long dreamed of owning a home, but you want to be certain that you don’t end up in a similar situation.
Although you’re employed and save what you can, you know your poor credit history, amount of debt, and your current household income level will likely negatively affect your chances of becoming a homeowner.
So, what’s the solution?
For many, it’s taking out a home loan.
In this post, we’ll examine the differences between conventional loans vs FHA loans.
Read on to learn more about which one is the right fit for you.
What Is a Conventional Loan?
So, what are conventional loans vs FHA loans?
The former is certainly one of the most popular ways to finance the purchase of a home.
The main thing that separates a convention loan from an FHA loan is that while FHA loans are backed by the government, convention loans are not. The guidelines associated with a conventional loan are created by Freddie Mac and Fannie Mae.
The maximum borrowing amount changes every year in accordance with the average cost of buying a home.
Conventional loans are backed entirely by private lenders, and you as the borrower will be responsible for making repayments.
This means if you default on your loan, the lender themselves will be responsible for those payments. As you’ve likely guessed, picking up the tab for your home is something no conventional lender is interested in doing.
This means that conventional loans will have stricter application requirements than FHA loans typically carry.
Let’s take a look at some of what you’ll be responsible for under a conventional loan agreement below.
Benefits of Conventional Loans
Conventional loans often have higher borrowing limits than FHA loans.
Additionally, you’ll have major flexibility when it comes to the terms of your loan. You’ll be able to set a repayment period between eight and thirty years.
Especially for those interested in investment homes or even buying a vacation home, conventional loans can be incredibly helpful. You’ll also have the opportunity to “shop around” for the best conventional loan terms and financing options.
This means, as you’d expect, that you’ll need to have a strong credit score and a low overall debt-to-income ratio. In order to be approved for conventional loans, you’ll need to have a minimum credit score of 620, and a debt-to-income ratio of 50% or lower.
Be aware that for many, the main drawback to conventional loans is that they often require a higher down payment than FHA loans. While in rare cases, you may be able to make a down payment as low as 3%, usually, you’ll need to be able to make one that’s anywhere 5-20%.
There’s an incentive for making that higher down payment. You’ll usually have to make monthly payments if your down payment was under 20%. However, if you can make a down payment of at least 20%, you’ll be able to avoid making private mortgage insurance (PMI) payments.
Understanding FHA Loans
Now, let’s examine an FHA loan vs conventional loan options.
FHA stands for “Federal Housing Administration,” meaning that these loans are actually backed by the government, although still issued by banks, credit unions, and other financial institutions.
This means that, if the lender is unable to pay back the loan, the FHA will make the payments to the lender.
Many aspiring homeowners apply for an FHA loan because they need higher loan amounts, and especially because they don’t have a strong credit history or other financial pre-requisites traditional lenders would require.
So, what else should you know when you’re planning on applying for FHA loans?
Let’s take a closer look below.
When to Apply for FHA Loans
There are countless advantages to FHA loans, though perhaps one of the biggest is that you can be approved even if your credit score is as low as 580.
FHA loans also generally offer smaller down payments, generally 3.5% and above. So, if you don’t have lots of cash on hand for a down payment, you’ll likely go for an FHA loan over a conventional option.
Additionally, you’ll be able to have a co-signer on an FHA loan if you need one. In more good news, there is no prepayment penalty associated with FHA loans.
However, be aware that FHA loans also have their downside.
First, you’ll need to pay 1.75% MIP (mortgage insurance premium) when you close on your home — even if you also made a large down payment.
You can’t use them to fund the purchase of second homes, including investment properties. They don’t have as much flexibility regarding the term of the loan as some would like, meaning you can choose only between 15, 20, 25, and 30-year terms.
You’ll also have to pay an MIP over the life of the loan if your down payment was under 10%, but you can end that MIP after 11 years if your down payment was over 10%.
If you’re still not certain which option is the right one for you, then consider meeting with a mortgage broker to get professional advice.
Conventional Loans vs FHA Loans: Wrapping Up
We understand that it can often be difficult to choose between conventional loans vs FHA loans, but we hope this post has made the decision clearer for you.
Remember to closely examine your current financial situation, and make the most realistic choice.
Now is the time to start doing what you can when it comes to strengthening your credit score, cutting out unnecessary expenses, and making sure you choose a home that fits with your present and future budget.
A large loan isn’t a “free pass” to buy a larger or more expensive home that you need.
Ready to apply for an FHA loan or a conventional loan? Want additional advice about which loan option is the best fit for you?
We’re here to help.
Reach out to us to learn how we can help you to finance the home of your dreams.