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The Difference Between FHA and Conventional Mortgage Loans

Posted by : Premraj | Posted on : Tuesday, October 3, 2017

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Buying your first home can be one of the most rewarding and exciting times of your life, but it can also be one of the most daunting experiences you will face. Either way, it will be a learning experience, and it is important to familiarize yourself with all the different options, fees, loans and other aspects that can help you get the most out of the experience.

One of the most common questions about first-time mortgage loans is: What is the difference between an FHA loan and a conventional loan? While both loans are generally available from the same lenders, there are many differences between them. They both come from lenders in the private sector, but the biggest difference is that FHA loans are insured by the government, whereas conventional loans have no guarantee for the lender.

Mortgage Insurance

Mortgage insurance is a safeguard that is put in place in case borrowers are unable to pay their mortgage and default on their loans. It is important to understand that this insures the lender (usually the bank or the financial institution), not the borrower. In the case of an FHA loan, the government will recoup the losses for the lending institution.

With a conventional loan, there is no guarantee of default repayment included within the loan. Because of this, many lenders will require private mortgage insurance (PMI) to be paid along with a conventional loan if the down payment is less than a certain amount– usually 20 percent. Aside from the insurance aspect, there are several other areas in which the two types of loans differ.

Conventional Loans

These are the standard mortgage loans that banks and other lenders have given to homeowners for decades. Because there is no guarantee for the lender if the borrower defaults, the qualifications and requirements are usually stricter. The requirements, rates and down payment amounts will vary according to the lender, but the following are basic guidelines that are common in the mortgage industry.

Qualifications: Because there is no guarantee for the lender, the credit and financial qualifications will be stricter. Conventional loans require the borrower to have good credit, a steady income and be able to afford the down payment, and other requirements will be more specific according to the policies of individual lenders.

Down Payment: Conventional loans require significantly higher down payments than FHA loans. Most commonly, lenders require 20 percent of the total purchase amount, but it may go lower depending on your qualifications and the requirements of the financial institution.

Mortgage Insurance: Because conventional loans are not guaranteed by the government, if you pay less than 20 percent down, most lenders will require you to carry private mortgage insurance. Some lenders allow this PMI to be dropped once the home has reached a certain amount of equity.

Loan Types and Limits: Lenders have more flexibility in offering shorter or longer terms, adjustable rates and other differences with conventional loans. There is generally no limit for conventional loan amounts.

FHA Loans

The Federal Housing Administration is a federal institution that provides insurance to mortgage lenders if a borrower defaults on an FHA loan. The government does not provide the loan, so FHA mortgages are still loaned by the same institutions in the private sector as conventional loans.

Qualifications: FHA loans have lower standards of qualification than conventional loans. Individuals with credit within the 500s can even qualify for these loans, but the lender still sets their own requirements.

Down Payment: FHA loans require lower down payments than conventional loans. Some lenders require as little as 3 percent of the total cost. Also unlike conventional loans, the entire down payment amount can be a gift from a family member or an institution.

Mortgage Insurance: The Federal Housing Administration provides insurance for FHA loans. A large amount of the insurance premium will be required at closing, and the premiums will be included in your monthly payment throughout the length of the loan.

Loan Types and Limits: FHA loans are generally 30-year fixed rate mortgages. There is also a limit set on how much can be loaned depending on the area. This means that areas with higher average real estate prices will have higher FHA loan limits.

 

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