When you’re house hunting you’re quickly going to find that there are different options available when it comes to the loan. Most of these loans fall into one of two categories – Federal Housing Administration or Conventional- which means at some point you’ll more than likely want to compare the two. When pitted against each other both options have a lot of benefits and a lot of disadvantages, and eventually it boils down to your financial situation and your personal preference. But before that decision is made, here’s a look at FHA loans vs. conventional loans.
Pros of a Federally Backed Loan Compared to a Conventional Loan
As a potential homeowner a few of your biggest concerns are going to be credit score, down payments, and closing costs. With an FHA loan you are not required to have perfect credit for approval. Instead, you just need to make sure your score is at least 580. This number will vary depending on the lender, but the federal standard is currently set at 580. Conventional lenders are stricter because they carry more risk, so the credit score usually needs to be at least in the six hundreds. However, if you qualify and the score is in the low six hundreds, your interest rate will be higher because you will be perceived as a higher risk investment.
Once you’ve qualified for a loan, you’re going to have to figure out the down payment. Federally backed loans typically require somewhere around 3.5% of the loan as a down payment. This can have a huge impact financially for the potential homeowner. A 3.5% down payment is manageable and shouldn’t be too difficult to secure. In addition, down payment financing can be gifted by a family member or pulled from savings. So for the numbers you’re looking at around 3.5% for an FHA loan vs. 10% or more for a conventional loan. That’s a significant dollar amount.
The closing costs are another major concern because they have to come out of somebody’s pocket. With government approved loan the closings costs do need to be paid, absolutely, but they can be rolled into the loan and then paid off over time, along with your mortgage. You just need to discuss with your lender the option of financing the costs with the loan. You may be able to do a seller assist with a conventional loan, where the seller pays part of the closing costs, but that will depend on your lender and the contract you work out with the seller.
Cons of a Federally Insured Loan Compared to a Conventional Loan
Financially the Federal Housing Administration loans offer a lot of pros that absolutely work to your benefit, but they’re not perfect or foolproof. Because the loans go through a federal administration, you will have to choose from the options they offer. Unfortunately, you will find more loan options through the conventional loan method. In addition, Federal Housing Administrations loans are government insured and you, the homeowner, will more than likely be required to have mortgage insurance on the property. This insurance can also be difficult to cancel if, for some reason, the need comes up to do so. Another disadvantage of these loans is that you can only secure one if you intend to live in the home. They cannot be used for purchase of additional homes or investment properties. You can only have one federally insured loan, no more. With a conventional loan you are not required to insure the mortgage, you are not required to live in the home, and you are able to hold multiple traditional loans at once. When comparing FHA loans vs. conventional loans for investments, conventional loans definitely win out.
When all is said and done, the toss up between FHA loans vs. conventional loans is a pretty even mix. Each type offers a unique set of benefits to a potential property owner, and each offers a unique set of disadvantages. What it will boil down to when it comes to your own decision will be your needs at the time the loan is applied for. If you’re finances aren’t perfect and you’re looking to get into a home despite that, the federally insured option will be the one you’ll want to look at first – they are there to help you become the proud owner of a new home. However, if your financial portfolio looks good and your credit score is good, a conventional loan may be the better option for you.