One of the first steps to purchasing a property and buying a home is to find a good mortgage lender. Many lenders offer both conventional loans and FHA loans. When shopping around for your home mortgage, talk to your lender and see which type of loan would work best for you. Luckily, there are several options to choose from, including conventional and FHA loans.
Hot tip for first-time home buyers: Choose your lender beforehand and get a pre-qualification letter that will put you in a better position to make an offer quickly.
Approximately 65% of homeowners purchase their home with a conventional loan. In a conventional home mortgage, buyers work with the lender to find a down payment, mortgage length and interest rate that mutually benefit both parties. The lender can then finance the loan themselves in a “portfolio” loan or sell the loan to a third-party investor. Conventional loans are what most people consider the traditional way of securing a home mortgage, and they conform to requirements set forth annually by Fannie Mae and Freddie Mac, nationally recognized authorities on mortgages.
Requirements in a conventional loan include an average credit score of 720, though the minimum permitted by some lenders is 620. Since there is no minimum requirement for a down payment, some buyers start as low as 3%. However, the lower the down payment, the higher the interest rates will be. Also, if the buyer is unable to pay the full 20% on the down payment, lenders will require private mortgage insurance (PMI) until that 20% is paid off.
An FHA is slightly different from a conventional loan because these types of loans are backed by the Federal Housing Administration, a branch of the Federal government. That means that if you default on the loan, the government will pay the lender the remaining amount.
When evaluating the type of FHA that works best for you, buyers can choose between a fixed-rate mortgage and an adjustable-rate mortgage (ARM). The interest rates of a fixed-rate mortgage stay the same during the entire life of the loan. Most borrowers choose this option in order to calculate exactly how much they’ll owe on a monthly basis; it will never change.
An adjustable-rate mortgage has a more flexible interest rate, and the rates can fluctuate as often as twice a year. While there are different types of ARMs, the most popular one is the FHA 5/1 ARM. In this agreement, buyers lock in a low interest rate for the first five years, after which point it goes up or down according to inflation and market price. However, it cannot change by more than 1%. The 5/1 ARM is an ideal option for buyers who don’t plan to stay in the home for the entire length of the mortgage or who prefer to lock in on lower interest rates.
Pros of an FHA Loan
Typically, FHA loans are favorable for first-time home buyers who have a lower credit score or less capital to put towards the initial down payment.
Lower Down Payment. Buyers can qualify for an FHA loan with as little as a 3.5% down payment.
Minimum FICO Score. Conventional loans favor buyers with higher credit scores, but FHA loans will qualify buyers with credit scores of 500.
Lower Closing Costs. Buyers are only required to pay 3 to 5% of the loan amount on closing costs.
Money for House Renovations. One type of FHA loan, called the FHA 203K, provides extra money for buyers to make renovations on a fixer-upper.
No Minimum Income. The lender only needs to see that buyers earn enough to pay back the loan, but there is no minimum income requirement.
Lower Interest Rates. Since the government is backing the loan, the lender takes on less risk and therefore will charge less interest on the home mortgage.
Cons of an FHA Loan
Mortgage Insurance. Buyers are required to pay for mortgage insurance throughout the duration of their loan in case they default on payments. Unlike conventional loans, buyers must continue paying for this mortgage insurance even after 20% of their residence is paid off. This insurance is impossible to get out of and can often require higher payments than insurance with a conventional loan.
Primary Residence. You cannot apply for an FHA loan on a vacation home or investment property – it must be your primary residence.
Loan limits. There is a limit to how much the FHA will loan a buyer. In pricey or popular areas where housing is more expensive, an FHA might not be feasible.
These are the main differences between a conventional loan and an FHA loan. If you want to learn more about home mortgages, we’d love to answer any further questions, or connect you with quality mortgage brokers here in Western, NC. We can also take you around the area to explore the available mountain homes. Give us a call today.