With mortgage rates being at record lows, many people are ready to buy their first home or refinance their existing mortgage. If you’re one of the many Americans who want to capitalize on one of the best times in many generations to buy or refinance a home, you’re probably looking into the loan options available to you.
If you’re a first-time home buyer or haven’t thought about your existing mortgage in years, it may be hard to tell which loan option will be the best for your situation. Two of the most common mortgages right now are conventional, fixed-rate mortgages and the government-backed FHA loans. Each mortgage offers unique features that serve different situations. Knowing the difference between the two will help make your decision easier:
The Federal Housing Administration (FHA) insures FHA loans, which protects the lender in the event that the borrower defaults on the loan, making these loans less risky for lenders. This is why lenders are more likely to offer low-interest rates on them.
If an applicant has a credit score of at least 580, the down payment on an FHA loan will be 3.5%. If the applicant has a lower credit score, the down payment will increase to 10%. Although the FHA does allow for loans to be granted to people with credit scores below 620, most lenders today don’t. The FHA also requires that applicants have at least one year free of any delinquent mortgage or rent payments.
All things considered, FHA loans have less strict credit and income requirements compared to other home loans. These loans also allow homeowners to refinance a greater value of their home (up to 97 %!) and feature a streamline refinance option, which requires less documentation and quicker processing.
Conventional loans aren’t insured by the government, so lenders mitigate their risk by imposing tighter qualification standards. These loans tend to have higher interest rates than FHA loans because the rates are more likely to be driven by a borrower’s credit scores and other risk factors. With a conventional loan, an applicant needs to have a good credit score and income to be awarded reasonable loan terms.
The down payment on conventional loans tends to be higher, with the requirement currently set around 10% for most loans. Applicants will need to have a credit score of 660 or higher to be eligible and, in most cases, will need a 700 to receive competitive interest rates. There’s no upfront mortgage premium requirement, but there will be monthly mortgage insurance if the borrower’s loan-to-value ratio is greater than or equal to 80%. There are refinancing options with conventional loans, but the amount a homeowner can refinance is only 80% for cash out and 95% for non-cash out, compared to 85% and 97% respectively for FHA loans. There is also no streamline refinance option available.
An FHA loan would likely be more beneficial for those wanting to borrow more than 80% of the purchase price or home value, those with lower credit scores or those who do not have a lot of money for a down payment because they can have access to lower interest rates. This loan might also be better for borrowers who want a cash-out loan because they will probably receive a lower rate than with a conventional loan.
On the other hand, a conventional loan may be better for those who have excellent credit, those borrowing less than 80% of the purchase price/home value and those not wanting to get a cash-out loan because they can receive low-interest rates and, unlike FHA loans, they won’t have mortgage insurance if the loan amount is less than 80% of the purchase price or home value. Furthermore, because conventional loans are offered through private lenders without government restraints, they typically offer more room for negotiation and are more flexible.
Both FHA and Conventional loans have their pros and cons and they both provide a quality home finance product for qualified consumers. Having said that, it is important that you assess your financial situation and understand all the terms of your mortgage before signing any paperwork! Knowing what you need from your mortgage and what you can afford can help you ensure that there will not be any financial constraints in paying up loans in the long run.
Prospect Financial Group
948 Garnet Avenue
San Diego, CA 92109
NMLS: 349089 | BRE: 01837707
Jason Vondrak has been in the mortgage industry since 2004 and co-founded the mortgage brokerage Prospect Financial Group in 2006 in San Diego, California. Today he serves as President and CEO of Prospect Financial Group and the president and founder of Prospect Property Group, a real estate development company, established in 2012.
“I’ve had the privilege to serve in an industry that exists to ensure homeownership remains among the top priorities of government and citizens alike. Over the years, it has been a pleasure working alongside homeowners, real estate professionals, and business associates combining efforts and teaming up to help homeowners realize the dream of home ownership.”