Thursday, 10 October 2019

The Difference Between FHA and Conventional Home Loans

Between FHA and Conventional Home Loans

People always ask the question saying should I go with FHA or should I go with conventional. Both of them sound the same and when you talk to a lender, they have similar numbers but no one really takes the time to explain what are the actual differences between each of them. 

In today article I will quick synopsis of each loan, what the pros and cons of each one are, and hopefully, it helps you narrow down which decision to make, FHA or conventional

Let's Get Started


FHA

FHA has been popular for the last 6 years, the reason is that their interest rate has been ridiculously lower. Not only that but even they have released in the downpayment assistance program in 5, where folks were able to get this low-interest rate, it really cost almost nothing to buy a home as long as they have the qualifying factors.

FHA just like VA or USDA is a government-backed mortgage loan, it's very simple, it's like a one-credit score fits all kinds of situation, I think the minimum credit score is 600 if not 580 in special situations. But as long as you qualify for that credit score you have got the whole package.

The interest rate has been historically a lot lower than conventional loans, so, technically unless something changes.

The downpayment is really simple, 3.5%, please note that everything changes, so, let's stick to the basic one for now. You could put more down if you want but if you put more down payment it's not the benefit of the actual loan, it's just going to make amount less.

I have another article where I talk about 



Mortgage insurance

What surprising to a lot of people in mortgage insurance. Mortgage insurance is basically an entity insuring the lender against you, meaning if you decide to default your lender, this insurance is going to kick in and give the money to the lender and then that goes to the government.

With FHA

It sticks with the life of the loan, it doesn't matter if you have a 50% off, 20% paid off, 80% paid off. If you are about to pay it off the next month after 29 years of hard work, it doesn't matter, you are paying that same mortgage insurance for the entire life of the loan.

The only way that is going to change is if you refinance it or you paid it off. It's almost like you could put more money towards it, you can make extra payments towards your house while you are living in it. That is the thing about FHA, you get what you get, you are going to stick with it and that is the same thing you are going to have for the rest of your life.


The Benefit Of FHA

If your credit score isn't that great, you don't have much the downpayment, it's a great option for a first time homebuyer because like I said you could have a 600 credit score as long as you have the 3.5% down. You will be able to qualify, you are not going to get less or harsher thing because you are close to that 600 marks.

For folks that maybe didn't make the right life decisions or had some mistake earlier in their life and now their credit is not as great as they want it to be, well, it doesn't have to be that bad. Their assistance programs do require you to be closer to 660 but if you have a 3.5% downpayment, you could definitely do standard FHA.


Conventional

Conventional is a mortgage loan that is conforming, conforming meaning it's under the guideline of Fannie Mae and Freddie Mac. Which are government corporations but their loans are conforming to their guidelines? They are technically about the same guidelines of FHA, there are some very slight differences but it's still very much secure mortgage 

Favors Buyer With Better Credit Score

Because conventional is not backed by the government there is a lot more at play here. This is not definitely a one-credit score fits all situations,

Let's say the minimum credit score for a conventional might be 620, well, if you have 620 and another buyer next door to you is at a 750, that buyer at 750 is going to get a lot better terms then you. They are going to get offered a better interest rate, they are going to get off with less mortgage insurance, and overall they are going to get a better package and they have a lot more negotiating power, meaning they can go to several lenders and they can even compete for their business because they know that is a very solid buyer.

If your credit score is at 621 or 620, although you are going to get a thing and you can shop it around you are not going to get the best interest rate, you are not going to get the best mortgage insurance and really there is not much you can do about that unless you stop or your credits score is high.

If you have been very meticulous about your credit score, you took care of it really well, and it's something you have great pride in, this is a great option for you, you will see the reward in it, whereas FHA is doesn't matter, with conventional you can actually get a reward from you taking care of your credit.

But with conventional you will have a higher down payment, the minimum down payment for a conventional product is about 3% to 20% 


Interest Rate Tends To Be A Bit Higher Than FHA

They are not that different now because maybe conventional is still a little higher but back in the day, it was at least 1 to 2 to 3 points higher than FHA. Even now it's still 1 to 2 point higher in some situations depending on your credit score.

But if you are barely out of 620 and you are again looking at conventional and FHA product, even though conventional you are putting 3% downpayment and then FHA 3.5% downpayment. It might make more sense to go with FHA because the monthly payment will be less because the interest rates are a lot lesser. It's a little bit less than the conventional one. 


  • A lot of people don't think a half-point or a 1 point of interest affects you, but at the end of the day, it might be a difference of $50 to $100, depending on your price range.

Huge Advantage Of Conventional Product.

Remember we talked about the mortgage insurance with FHA, whatever you get when you first get your home, that mortgage insurance, it's what you are going to pay for the rest of your life or the 30 years unless you decide to refinance it or sell it and get another home.


Mortgage Insurance Drop Once You Reach 80 to 20 Loan To Value

Conventional, it's a little bit different, as soon as you reach about 80 to 20 loan value of your home, that mortgage insurance gets booted out and is no longer on your monthly payment.

Lets me explain

Lets me just use the number $100,000, lets say you buy a house for $100,000 and you put 3% down, your total loan when you buy the home is about $97,000, so, as you live in the home you are going to be making payments, so, maybe after 1 or 2 years you are at $90,000, $94,000, lets just say about 8 years later you owe about $80,000 on the home and your original value of that was a $100,000.

That means that your loan is $80,000, the value of the home is $100,000, so, you would be at $80,000 to $20,000 value. But wait, that really doesn't make sense right, and if you did catch it, well, here is the thing.

When you are living in a home, you are paying your mortgage down and your loan goes down, but guess what, if the market is good which is how it's been recent, your value also going to go up, so, there are like two factors working toward.

But here it makes sense, if you want to put more for the principal it helps you widen the gap a little more, so, as your home gets more value because the markets going up, your home is getting paid and maybe if you make extra payments, it goes even lower, I have seen people meet that 80 to 20 of value about 3 to 5 years.

The mortgage insurance which could be a $100, $200, on your monthly payments gets knocked out, now you are purely paying your mortgage, your interest, your taxes, and your insurance, that is it, you are not paying anything other additional. 

I like seeing progress, if you want to make the extra effort to make extra payments it's going to help you because if you can reach that 80 to 20 loan value a lot quicker than most people, then you are going to be able to mock and save yourself those extra few $100 a month, whereas with FHA you are not going to ever be able to take that off.



Conclusion

I'm not basing FHA, FHA is not a bad product but my recommendation is if it's a first home that you know you are only going to live for a few years, maybe 3 to 5 years and that is the best options you can because your credit score isn't that great, 

Well, get that home. It's better than renting, don't throw your money paying rent, get the home and live in there comfortably maybe fix it up a little and then when it's time to buy the next home, you are going to sell that home, get the equity from it to pay your down payment for the next home and make sure your credit is as high as possible. 

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