If you are a homeowner, your mortgage is likely the biggest piece of your monthly spending. This means that as a prospective home buyer, it is absolutely crucial that you do your due diligence and pick the right mortgage for you. Monthly payments on your mortgage may be up to 40% of your total income each month! Understanding the main differences between the two main types of loans - conventional loans and FHA loans - is actually pretty easy, and this post will explain everything you need to know.

 

What Is a Conventional Mortgage Loan?

A conventional loan is what most people think of when they imagine a mortgage. Conventional loans are provided by banks and other large mortgage lenders. The life of the loan may vary, but it is usually 30 years.

Conventional loans are typically the better option if you have a higher credit score, a lower debt-to-income ratio, and are generally in a better financial situation. The terms on a conventional loan are typically more favorable than the terms on an FHA loan, largely due to the stricter requirements you need to meet to even get approved. Private lenders assume all of the risk when they write a conventional mortgage, which is a large reason that their credit score requirements are much tighter.

If you are unsure whether or not you'd qualify for a conventional mortgage, the best thing to do is talk to your loan officer. The process can be especially complicated for first-time home buyers, and mortgage loan officers can help you figure out things like the best down payment amount, understand conventional mortgage rates, and more.

 

 

What Is an FHA Loan?

An FHA home loan is another type of mortgage. FHA loans are often great options for first-time homebuyers due to their low minimum credit score requirement and the possibility for very low down payments. Each FHA mortgage loan is backed by the Federal Housing Administration, which makes FHA-approved lenders much more willing to take on otherwise unfavorable risks.

FHA lenders are often the same banks are conventional lenders. In fact, when applying for a mortgage, it is not uncommon to be offered both options. Generally speaking, if you have enough cash to meet the down payment requirement on a conventional home loan, it is probably the best fit.

One very unique thing about FHA loans is the FHA mortgage insurance requirement. As FHA loans are usually designed for individuals with lower credit scores and down payments, they are naturally riskier. For this reason, FHA borrowers are required to pay private mortgage insurance both up front and each year. The upfront mortgage insurance premium is a small price to pay for the lower credit score and down payment requirements, but it is still a decent chunk of change.

 

Key Differences Between Conventional Mortgages and FHA Mortgages

Not all mortgages are created equally. Each type of loan is unique from one another, and there are more than just these two types! VA loans and USDA loans are the two other main types of mortgages, but they aren't nearly as common as conventional and FHA mortgages.

Primary Residence Requirement

The first key difference between conventional home loans and FHA home loans is the primary residency requirement. If you are looking to buy a second home, you probably won't be able to do it via an FHA loan. FHA loans are only issued for primary residences, so unless you plan on making the second home your primary residence, you will likely need to opt for a conventional mortgage.

Looser Financial Requirements and Lower Interest Rates

As we have mentioned, FHA loans are backed by a government agency. This guarantee helps lenders to write riskier business all while offering lower interest rates. While the interest rate may be lower, the monthly mortgage payment may still be higher because of mortgage insurance premiums.

Conventional loans are not backed by a federal agency, so banks fully assume all the risk when they write the loan. For this reason, they require a very good credit history, higher interest rates, and a minimum down payment. While these requirements are often steep, they do provide flexibility. Conventional loan limits are generally much higher than a typical FHA loan limit, they can be used for investment properties, and they may not require any kind of annual mortgage insurance premium.

Private Mortgage Insurance Requirements

FHA loans notoriously require a lot of private mortgage insurance (PMI) because of their favorable rates. This insurance is assessed both as an upfront premium at closing and a monthly premium throughout the loan. This PMI can be very costly over time, and it can even result in higher monthly payments than a conventional loan, despite the lower rate.

Conventional loans are much more straightforward when it comes to mortgage insurance. Generally, a buyer will need to pay PMI until they have 20% equity in the home. This means that if you are able to put 20% down on the house, you will never have to pay PMI. Similarly, if you can only afford to put 15% down on the house, you will be done paying PMI within a couple of years as soon as you have 20% equity.

 

 

Which Loan Type Is Right for You?

Every financial situation is different, which means that the better choice for each person can vary. However, your financial situation paints a good picture of which mortgage type is best for you. If you have great credit and significant cash on hand, a conventional mortgage may be the best option for you. If you are looking to buy an investment property, a conventional mortgage may be the only option for you.

If you have less-than-stellar credit, are a first-time home buyer, or have some high balances to pay off on your credit cards, FHA loans may be a better option for you. Their favorable lending criteria make buying a home accessible to many people who otherwise would not be able to do so, but the terms are not the best in the long run. Of these two loan options, FHA loans generally cost less in the beginning and more over time, while conventional loans cost much more in the beginning but significantly less in the long run.

 

What Are Fannie Mae and Freddie Mac?

Fannie Mae and Freddie Mac are two companies that work closely with the Federal Housing Finance Agency (FHFA) to keep the mortgage market moving. They do not write mortgages themselves but rather buy mortgage contracts from other lenders. By assuming loans from popular mortgage lenders at a low cost, the lenders are then able to write more business.

These two companies got a bad reputation during the financial crisis of 2008, but they exist to make housing more accessible across the United States. In any case, you will not work with either of them while you go through the process of buying a home, as they do not actually write mortgages.

 

Thanks for reading our post on the key differences between conventional mortgages and FHA mortgages. Hopefully, this post helped you to better understand the most common mortgage options as you get ready to purchase a home. Your mortgage is probably the largest financial commitment you will make in your life, which is why it is so important to understand what you are signing up for before you actually sign anything.

 

If you visit Myrtle Beach or any other place in South Carolina and fall in love, we’re here to help. We at The Boyd Team are committed to helping you find the right property for your needs and dreams. Any question that you have about moving to the area and finding your dream home by the beach is our pleasure to answer. Feel free to send us an email at eddie@boydteam.com or text or call us at (843) 222-8566, and we will get back to you as soon as we can. Being true natives of the Grand Strand and Horry County and with over 25 years of experience in the local real estate market, whether buying or selling, we can help you make your dreams a reality.  

No One Knows The Grand Strand Better! Trust, Knowledge, Experience, and Professionalism You Can Count On!