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Conventional vs. FHA Mortgage — which is better for me?

Chances are that if you are reading this, you’ve either come far enough in the process of buying a home or are getting serious enough to do the research that’s needed. After all, Mortgage isn’t something one has to deal with very frequently. For some, it’s a once in a lifetime kind of an event. Since it’s perhaps the biggest purchase most ever do, due diligence is of utmost importance.

Once you get into the home buying process and get to the step of finding the right mortgage, you hear of so many new related terms and options. These are likely to overwhelm you since this is stuff you’ve never had to encounter in the past. Amongst the so many different questions that people ask us, the one that is a fairly common one is: “What is the difference between a Conventional Mortgage and an FHA mortgage? And which is better for me? Here, we try to take a deeper dive and help you answer that question.

How does a mortgage work?

Getting almost any type of mortgage in the US entails making a down payment (the fraction of the home price that the buyer pays) and borrowing the rest from a bank or a lender. The bank charges you a rate of interest on that amount that you borrow, for the term of the loan. The goal that every borrower has is to get as low a rate as possible. How good a rate one gets is dependent heavily on one major factor: the Median Tri-Merge credit score”. It is basically a score that tells the lender how diligent you have been about making payments on loans you’ve taken on in the past. The better your history of making those payments is, the more reliable you are in paying back a loan and the lower the rate you can get.

What is an FHA Mortgage?

Everyone dreams of owning a home. To help people with lower scores own homes, the US Department of Housing and Urban Development (HUD) runs a program called the FHA Loan program. The way this program works is that within the HUD, there is an agency called the Federal Housing Administration (FHA) that primarily deals with residential lending for primary residences. (Read more about the HUD and FHA here). The main role of this agency is to insure residential loans made under the program so the FHA-approved lenders feel more comfortable making loans to lower quality borrowers.

To help people with lower scores own homes, the US Department of Housing and Urban Development (HUD) runs a program called the FHA Loan program Click To Tweet

Does a conventional mortgage not require insurance?

The short answer is: it does, but only in certain situations. Typically, if you make a large down-payment, you are not required to buy any insurance on the loan. That saves you on the insurance premium that FHA borrowers have to pay.

Should I ever explore an FHA loan even though I am eligible for a conventional loan?

The answer again is: Yes, in situations where lender offered FHA loan terms are better than those for a conventional loan.

For many borrowers, the interest rate on an FHA loan can be lower than that on a conventional loan.

One reason people may not still go for an FHA loan and instead get a conventional loan is because they’ll save more with the latter by not having to pay for mortgage insurance at all (or pay less overall).

Of course, the loan amount has to be lower than the county's FHA loan limit.

The one worry home buyers have is that if they get the FHA loan with high loan-to-value, they cannot cancel the mortgage insurance and it’s due for the life of the loan.

In such a case, you have the choice to refinance later when conventional starts to become more favorable. There are closing costs for the re-finance that you still have to take into account, but something to think about if you are saving enough upfront.

That was a lot of information. Let’s summarize and give you some rules of thumb.

  • If the loan amount is higher than the FHA limit for the county in which the home is located, and you aren't eligible for a VA or USDA loan, a conventional loan is an option to consider.
  • If the loan amount is below the FHA limit, review loan estimates for an FHA loan and a conventional loan scenario.
  • You also have to take into account the upfront premium that FHA loans cost you and the fact that you might incur refinancing cost with an FHA loan if later, when the credit improves, a conventional loan becomes cheaper and you decide to refinance.

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