While many people rely directly on their mortgage brokers or lenders to give them a recommendation on how they should finance their homes, you should understand the basic difference between an FHA Loan and a Conventional Loan. Conventional loans include all loans available under FNMA and FHLMC lending limits. These are commonly known as Conforming , A paper, subprime, Alt A, A Minus, BC as well as other industry names. The main difference between the Conventional Loan and the FHA loan is the credit and down payment it takes to receive approval and the fact that the government provides the FHA while private banks provide financing for the conventional.
FHA loans main advantages over the conventional loan is that credit qualifying for a home buyer is not as strict as for its counter part the Conventional loan and the down payment or equity requirements are less. When comparing the FHA loan to the Conventional or conforming, we typically see that the FHA will generally require about 3.5% down vs. 5% – 10% for the conforming Conventional. The FHA loan will also let the borrower who may have had a few credit problems or those without a lengthy credit history still qualify to buy a home. If the buyer does have a few credit problems the FHA underwriter will require a reasonable explanation of these mis-haps, most commonly borrowers with extenuating circumstances such as bankruptcy or other situations.
If a borrower does have past issues, an FHA loan may be significantly cheaper than doing a loan such as a sub prime, Alt A or a Minus A which typically we see buyers/borrowers with below average credit scores using as an only option for a conventional loan. These other conventional programs generally have higher interest rates and require a larger down payment or more equity in the house you are buying or re-financing.
One other advantage of the FHA loan is it is one of the only types of loans that allow a family member or other institution to gift the downpayment to the buyer in order to secure the house. This allows home buyers without the necessary cash down to still purchase a home.
Disadvantages of FHA:
- The FHA loan charges an annual renewal mortgage insurance premium of .5% to .55% of the loan amount
- Requires an upfront mortgage insurance premium of 1.75% of the loan amount that the borrower can wrap into the mortgage
- Loan limits for FHA are typically less than the loan limits for conventional financing