Conventional mortgages and FHA loans are two options borrowers have for funding a house purchase.
Would-be home buyers have a multitude of options when it comes to financing their purchase. In many cases, the choices can seem overwhelming, given the many financing options that are available. Two of the most common types are conventional mortgages and Federal Housing Administration (FHA) loans. One or the other is likely to better suit individual buyers' situations.
Conventional mortgages are often paid back over 15- or 30-year terms, and the lender assumes all risk associated with them. As a result, lending guidelines tend to be stricter as the lender tries to ensure repayment of the loan will occur. In most cases, conventional mortgages require a down payment of at least 5 percent of the purchase price. Also, borrowers who take out a conventional mortgage that is more than 80 percent of the value of the property they are purchasing will have to pay primary mortgage insurance. Typically, that amount is about $55 per month per $100,000 financed and is paid until the mortgage balance is less than 80 percent of the purchase price.
FHA loans are insured by the Federal Housing Administration. As a result, there is less risk to the lender, so the lending guidelines for FHA loans tend to be more relaxed than those for conventional loans. FHA loans require a down payment of 3.5 percent of the purchase price, which is lower than conventional mortgages. FHA loans do require an upfront insurance payment of 1.75 percent of the loan amount, but that money can be rolled into the overall mortgage. While the limits on FHA loans are smaller than those for conventional mortgages, FHA loans are especially good for borrowers who are buying their first home or who have a less-than-stellar credit history.
One of the main differences between conventional and FHA loans is in the amount of money borrowers must have on hand before they can take out the loan. With conventional loans, borrowers must have at least 5 percent of the purchase price and sometimes as much as 20 percent, as well as two months' worth of reserves. FHA borrowers need only 3.5 percent of the purchase price, and the money does not necessarily need to be their own. Instead, it can come in the form of a government grant or as a gift from a family member. Borrowers do not have to have any financial reserves.
Ability to Pay
A solid credit history is a necessity to qualify for a conventional mortgage, and borrowers typically must have a certain type of credit history. They must show they have paid back credit cards and mortgages, for example. Since FHA loans are somewhat targeted to first-time buyers, other types of credit can be used instead. FHA borrowers can show they have paid utilities, cable television bills or school tuition, for example.
Past credit history is an important consideration regardless of the type of loan. However, lenders of conventional mortgages typically look further back in a borrower's credit history. A person who had a bankruptcy discharged two years ago may be able to get an FHA loan, for example, while it likely would take at least four years from the discharge of a bankruptcy for a person to be approved for a conventional mortgage.