One of the big questions you’ll have to answer when you are ready to buy a home is what type of mortgage loan to choose. There are plenty of options out there, with conventional and FHA being among the most popular. If you’re unsure which kind is right for you, here’s what you need to know about these common mortgage choices.
Federal Housing Administration (FHA) loans are backed by that government agency with the intention of making mortgages more affordable to lower-income citizens. Because of that fact, they have become the go-to loan for first-time homebuyers since the mortgage crash of 2008. As stricter federal regulation made subprime loans much harder to obtain, those with less-than-ideal financial qualifications have found help from FHA loans.
Conventional loans are guaranteed by the government-sponsored entities Fannie Mae and Freddie Mac. These are not directly made or backed by the federal government, but once made by a private lender, Fannie or Freddie promise to buy them, taking the risk away from the lender and giving them more incentive to make more loans.
The minimum down payment requirements are similar between FHA and conventional loans. Depending on the borrower’s credit score, it can be as low as 3.5% for FHA and 3% for conventional. With both mortgages, borrowers can receive up to 100% of their down payment funds from gifts, making it easier for parents or grandparents to help homebuyers get into their first house.
A conventional loan requires a higher minimum credit score (620) compared with an FHA (580.) (However, at that grim level, the down payment requirement on the federal loan increases to 10%.) For this reason, FHA mortgages are very popular with first-time buyers and those in the lower income brackets. Of course, the better your credit score, the better your mortgage interest rate will be.
Interest rates on both types of loans tend to be very close, with FHA sometimes coming in slightly lower. The rates are mostly determined in either case by your credit score, down payment, loan-to-value ratio, and your other assets. Rates can also vary from lender to lender.
With conventional loans, borrowers must pay private mortgage insurance (PMI) until they have 20% equity in the home. That can happen by either paying down the principal of your loan over time, or gaining equity as your home value rises along with the market, or a combination of both. Until you reach that threshold though, you will have to pay PMI premiums to help protect your lender against possible default. This can cost you anywhere from 0.5% to 1.75% of your loan total every year. If you took out a $300,000 mortgage, and paid PMI at 1%, you’d be shelling out an extra $3,000 a year. The good news is that payment will disappear after your equity reaches 20%.
With FHA loans, you are required to pay mortgage insurance for the life of the loan. The rate is 1.75%, so the total cost may end up being more for an FHA than a conventional. However, you can refinance out of an FHA to a conventional down the road to eliminate that mortgage insurance premium.
While FHA and conventional loans share many features, there are a few ways they differ. The one that will better suit your needs will depend on your credit score and down payment as well as your ability to pay for mortgage insurance.
Give us a call today and we can discuss your particular situation and help you pick the option that is best for you!