October 19, 2017

FHA vs. Conventional

I find there is a lot of confusion about the difference between FHA and Conventional loans and when it’s best to go with one over the other.

There are hundreds of guidelines specific to each type of financing, and it’s best to have a conversation with your lender and discuss what is important to you, to determine the best course of action. You may find depending on your income or other criteria that you only qualify for one or the other.  That makes it a bit easier for you to decide.

I am not going to get technical here or go into the history of FHA loans.  It can really be boiled down to two basic criteria, the customer buying the property and the property itself.

It’s important to note that FHA financing is only available if the property is going to be used as the primary residence.  It’s also important to note that no matter how creative or convincing you think you are, you can only have one “Primary Residence”.

Ok, moving on. Lenders are concerned with two main ideas: 1. do we want to lend money to this borrower?, and 2. do we want to lend money on this property?  FHA guidelines are more flexible on the borrower and more restrictive on the property condition, while conventional guidelines are more restrictive on the borrower and can be more flexible on the property condition.

For example, in most cases, FHA programs allow for a lower credit score and higher debt ratio, but even if the borrower meets the qualifications for a certain loan amount, the property they’re interested in may not meet FHA standards. (For specific questions about the condition of a specific property, and whether it meets FHA standards, always confirm with an FHA approved lender.)

Conventional financing on the other isn’t as nit-picky on the property condition, while it still needs to be a safe, inhabitable residence.  Conventional programs do however have tighter restrictions on debt to income ratio and credit score.

If you find that you qualify for both conventional and FHA financing and the property you like would approve either way, then for the most part, conventional will be the most affordable route in the short term and perhaps even in the long term.

While in the recent past FHA loans were great alternatives for buyers with little money down (FHA only requires a 3.5% down payment), today conventional financing allows for only a 3% down payment if the credit score is good enough, and only a 5% down payment for most other buyers as long as the property is a primary residence.  You will have to carry private mortgage insurance for a while, but it will generally be lower than the monthly mortgage insurance required by FHA.  Also there is an option on conventional loans to buy out the PMI at a one time reduced cost, which may or may not be viable depending on your credit score and down payment.

On the other hand, while most FHA programs currently price out at slightly lower interest rates vs. their conventional counterparts, the monthly mortgage insurance is generally higher.  And, not only do you have to pay monthly insurance, but FHA loans require an up front premium in addition to the monthly fee.  Furthermore, all FHA loans require mortgage insurance no matter how much you put down. Conventional loans require no mortgage insurance if you can put at least 20% down.

In general, you need to understand you have options, even if you don’t have the 20% down payment.  So many customers come to me assuming they can only get FHA financing because of their down payment, and they come to find I will save them a lot of money because they qualify for a conventional loan.  That is not to say that FHA doesn’t have it’s benefits and it’s place in today’s purchase market.

I recently issued a pre-approval to a young man for his first home purchase.  While this particular buyer had saved the 20% to put down, had a good steady job history, almost no consumer debt, and a near perfect credit rating, his debt to income ratio was still just past the allowable limit under conventional guidelines at any realistic purchase price and interest rate. This is a perfect example of just one reason FHA loans are still a viable option for many buyers.

Please note this is only a basic comparison of FHA vs. Conventional.  Again, a qualified FHA lender would be the best person to discuss your specific scenario with to determine what makes the most sense for you. (I know a fantastic, qualified lender – see the “about me” section of this blog for contact information)

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