When you’re looking at different loan options, it usually boils down to two choices: FHA or Conventional loans. They both serve different purposes and goals depending on your situation. If you’re trying to figure out which one will save you money on your monthly payment or get you into your home faster, you’re in the right place. We’ve laid out the critical differences between FHA and Conventional loans so you can choose the option that makes the most sense for your future.
What’s the Difference?
An FHA loan is a mortgage insured by the government through the Federal Housing Administration. It’s a sort of safety-net loan because the FHA promises to pay back the lender if you stop making payments. This makes banks feel more comfortable lending the money to people whose financial history isn’t perfect. The protection an FHA loan provides allows lenders to offer more relaxed requirements than a conventional loan. These factors make FHA loans a common choice for first-time home-buyers or those who don’t have a lot of money readily available for a down payment.
A conventional loan is a mortgage that isn’t backed by a government agency. These types of loans are handled by private lenders, like banks or credit unions. Conventional loans are also typically sold to government-sponsored enterprises after they are taken out. This allows the private lender to continue to issue more loans to homebuyers. Due to the fact that there is no government guarantee behind the loan, the lender takes on more risk. Therefore, conventional loans often require a higher credit score and proof of a stable financial history to qualify.
Down Payments
The main difference in down payments is that FHA loans have a fixed minimum for most, whereas conventional loans can offer more variety. With an FHA loan, you only need to put down 3.5%, as long as your credit score is 580 or higher. If your score is between 500 and 579, a 10% down payment is required. However, the FHA is flexible about where that money comes from. If you’re unable to pay the down payment out of pocket, you can use gift funds from immediate family members. In addition to that, the FHA also allows you to use funds from employers, charitable organizations, or labor unions towards your down payment.
Conventional loans can offer an even lower down payment of 3%. However, this low of a down payment is usually reserved for first-time homebuyers who have strong credit. If you have owned a home before or are buying a second home, you will usually be expected to put down at least 5%, though you can put down more to avoid paying extra monthly fees. Lenders of conventional loans typically require a credit score of 620 or above to access low-down-payment options to begin with.
Credit Scores and Flexibility
FHA loans, because they are government-backed, lenders will accept a credit score as low as 580 with a small down payment. You won’t be smacked with high interest rates because your credit score isn’t at its height. This is part of what makes FHA a good option for those who have had a rocky financial past.
Conventional loans are much more rigid and reward those who have higher credit scores. Although you need at least a credit score of 620 to be considered, you can get the best rates and lowest insurance costs if your score is above 740. For those whose credit score is on the lower end of that scale, you’ll end up paying a much higher monthly payment. Conventional loans offer the most savings to those who have maintained a strong credit profile.
The Long-Term Cost
When looking at the long-term cost between these two loans, it becomes a question of “what’s easier now?” and “what’s cheaper later?” While an FHA may have a lower upfront interest rate, it can become expensive over the life of the mortgage because of its insurance structure. You’re required to pay an upfront mortgage insurance fee at closing, and for most buyers, the monthly insurance premiums never go away. Meaning, even after you’ve paid off half your house, you still have to pay a fee, which can add tens of thousands of dollars to the total cost of the loan over thirty years.
A conventional loan allows you to get rid of extra costs as you build equity. Although the interest rates might be slightly higher for those with a lower credit score, any mortgage insurance you pay is temporary. Once the balance of your loan drops to 80% of the home’s value, you can cancel that insurance, which will lower your monthly payment. Because of this, a conventional loan can lower the total price for your home in the long run.
Making the Choice
Deciding what loan to take out when buying a home can be daunting, even when you’ve done your homework. Luckily, Mortgage of Idaho is here to help you take out the right loan for your needs. Contact us today to learn more and get started on the mortgage process.
