If you have recently started shopping around for a new home loan, you may have spoken to a few lender representatives or mortgage brokers who have talked about FHA loans and conventional loans. Some may have recommended one option more heavily than the other. However, you should not simply take the advice of someone about something as significant as a home mortgage without understanding and comparing the options thoroughly. With this in mind, you need to initially understand what an FHA loan is and how it varies from other home loan options available.
Understanding What an FHA Loan Is
When a bank extends a home loan to a new client, they assume a considerable amount of financial risk. There is always a possibility that the client will default on the loan, and the bank will then incur fees for repossession, make-ready and selling the home. An FHA loan is a special type of loan that is insured by the federal government through the Federal Housing Administration. The bank has less financial risk when making an FHA loan because it is insured by the government. Because of this, you can expect a low down payment requirement. In fact, you may only have to pay 3.5 percent down with only one loan to manage. Lenders may be more lenient on the credit score requirement a well. These loans are not available through all lenders. Only FHA-approved lenders can offer these loans. You can use a gift of funds from a family member for the down payment. Keep in mind that if you place less than 20 percent down, you will need to pay a mortgage insurance payment, and this additional payment will remain in place over the life of the loan.
Exploring Other Home Loan Options
A conventional loan is essentially any type of standard bank loan that is not backed by the government. These loans may have competitive rates, and they do require mortgage insurance to be paid if you have less than 20 percent down. However, with a conventional loan, the PMI vanishes after you have 20 percent equity in the home. Some lenders will allow a first and second lien loan structure to give up to 95 percent or more loan-to-value. These loans are available with fixed and adjustable rates as well as balloon programs. Because there are so many variations in conventional loans, it is wise to carefully compare these programs individually.
Comparing the Options
The primary factors that set FHA loans apart from conventional loans are often the same factors that borrowers are most concerned about. These include the down payment requirement, the credit score requirement and the interest rate. You should pull your credit report before you begin shopping for a loan. With this information, you can easily eliminate some options. You may also review your finances to determine the down payment amount that you are most comfortable with. A higher LTV is most commonly associated with an FHA loan, but a conventional loan with a second lien as another possibility. Compare the monthly payments for both options before you decide how to proceed.
Making Your Final Decision
Many people will keep their home mortgage in place for several years or longer before refinancing it or selling the home. Some may even keep their loan for decades until they pay it off entirely. This means that your mortgage payment as well as your down payment decision will impact your finances for years to come. Take ample time to explore the options and to review their impact on your finances. If you are uncomfortable with the monthly payment or down payment requirement, shy away from that option. Continue your search until you find a solution that is right for you.
FHA loans offer many financial benefits, but they are not ideal for everyone. Because many lenders may attempt to steer you into an FHA loan, it is important to understand how these loans are different from other options and to thoroughly compare all options available. The best lenders will create two to four loan options for you to review in detail so that you can choose the best one for your needs, including both FHA and conventional loans.