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FHA vs Conventional Loan

Thursday, June 28, 2018   /   by Terri Bias

FHA vs Conventional Loan

A house is an expensive purchase. For most people, houses are likely to be the largest purchases you will ever make. Even when needing only 20% of the cost, that can still be a very large sum of money. There is another choice. The FHA loan is a government backed option that will help reduce the amount of money you will need upfront in order to purchase a house. The lower upfront costs comes some extra hoops to jump through however.

Before deciding if an FHA is worth consideration, let’s quickly breakdown the main points of a normal loan. A normal loan typically requires a higher credit score (620 or above is a good rule of thumb) and a 20% down payment. A $100k house would mean you need $20k (you’ll need more for closing costs and other fees, but as far as purely going to the mortgage that’s all you need). The FHA is a tad more complicated.

The pros:

-The most well-known pro of the FHA loan is the lower down payment. An FHA loan can be a cheap as 3.5% down. Meaning you can purchase (again ignoring closing costs at the moment) a $100k house for $3500. That is much easier to save for than the typical 20%.

-The down payment doesn’t necessarily need to come from you, it can be gifted. To sweeten the deal even more, if you’re rich uncle Beauregard III (or maybe just mom and dad) want to pay the down payment for you, they can. You are still responsible for the monthly payments, but that up-front burst can come from someone else.

-Larger income to debit ratio. A typical mortgage is capped somewhere around 36%. Meaning your payments and house payments cannot be more than 36% of your monthly income (if you make $1k a month, your total payments cannot be more than $360). This is more relaxed on this and will be somewhere in the 40%+ range. It is also possible that it can be 50% if you are a strong borrower, have a lot of cash in reserve, and have a good credit score.

-A lower credit score is needed. How low depends largely on where/who the loan is coming from and when you get one as it fluctuates. It will typically range between 500 and 620. Be sure to do your homework and see who offers what. Do note though that just because your score CAN be low, doesn’t necessarily mean anyone will give you the loan. As far as banks are concerned, your credit score equates to how reliably you will make payments. Just like with video games, the higher score wins.

-You can pay it off early with no fees. Some lenders will charge a fee if you pay off a mortgage early. They make money from your interest and removing that interest takes away some of their profit. To reduce some of this loss, there is sometimes a fee charged if you start deviating from the payment schedule. These fees do not apply to the FHA loan. You can pay it off without having to worry about being hit with an extra charge.

The cons:

-Mortgage Insurance. The lower down payment does come with a cost. Because the borrower is not putting as much money in the game, the bank stands to potentially lose more money if something goes wrong. This increased risk means that they are going to want the mortgage insured. There will more than likely be an additional upfront cost as well as a monthly payment.

-The property has to be in excellent condition. The FHA loan is a riskier loan to offer for a bank, so they are not willing to add even more risk by giving a mortgage on a “fixer upper” as well. The bank is going to send an inspector to make sure that everything is being held together on more than spit and prayers. The inspector is usually given a set of guidelines to follow and some inspectors may be a bit more gung ho about finding flaws.

-Limits on the loan amount. Most banks have a cap on how much they will put into an FHA loan. It varies on the area, but if you don’t live in a major city, then it’s a pretty safe bet that you will not be able to get an FHA for anything over $300k. The cap can also vary based on the bank.

-You have to live in the property for a while. The rule of thumb is that the borrower must live in the property for at least a year. That in itself is pretty straight forward. This also applies to a duplex, triplex, or fourplex. You are able to rent out the other units however, as long as you are living in one of them. This can add some extra income every month which may help cover the other fees.