When you decide to buy a house, you have two primary lending options: an FHA, or Federal Housing Administration, loan or a conventional loan. Both offer the financing you need to become a homeowner, but it's important to consider their pros and cons so you know which is best for your financial situation.
How Do Home Loans Work?
Both FHA loans and conventional loans involve a mortgage. You fill out an application, receive financing, make your down payment and pay your monthly mortgage installment. The total loan amount includes the principal, which is the amount you financed to buy your home, and interest, a percentage of the principal paid as a fee to the lender for the use of the money.
In both FHA and conventional loans, your home serves as collateral against default. If you don't make your mortgage payment, the lender can foreclose on your home and sell it to someone else to recover its losses. Consequently, it's important to choose a home you can afford, regardless of the type of loan you get.
It's also a good idea to consider multiple lenders within each group. Researching mortgage lenders helps you make an educated choice.
FHA Versus Conventional Loans
The main difference between FHA and conventional loan options is that FHA loans come with a government guarantee. The government doesn't issue the loan you must still borrow from a third-party lender but the Federal Housing Administration backs the loan in case you default. This way, the lender takes a lower risk.
FHA loans require smaller down payments. This allows first-time homebuyers, who don t have a lot of capital, to get into a home. Instead of private mortgage insurance, or PMI, FHA loans often require borrowers to pay mortgage insurance premiums, depending on the buyer's risk level.
Unlike conventional loans, FHA loans allow borrowers to use family, nonprofit or government gifts to make their down payments.
Conventional loans typically require the borrower to have higher credit scores and a better credit history than is required with an FHA loan. This is why consumers who have experienced credit problems, foreclosures or bankruptcies in the past might not secure a conventional loan, but may still qualify for an FHA loan.
However, conventional loans offer several advantages, such as lower interest rates and lower premiums. When a borrower reaches a certain equity threshold, he or she can cancel PMI, but FHA borrowers must continue to pay PMI for the life of the loan.
Choosing a Mortgage Option
When you're ready to buy a house, research lenders through both FHA and conventional avenues, such as Fannie Mae and Freddie Mac. Keep a record of the different interest rates, down-payment requirements and other details for each lender so you can compare them later. Using a mortgage review service can help you conduct your research.
FHA loans work best for consumers with low credit scores or insufficient capital, while conventional loans offer better terms for qualifying consumers. However, every consumer's financial situation is unique, so it's important to consider all your options before making a decision. A home is probably the largest investment you'll ever make.