Tuesday, October 6, 2009

FHA or Conventional Financing? What's the Difference?

There is a lot of confusion regarding when someone should get a conventional loan versus an FHA loan. Here's a brief overview of the differences:

FHA loans:
• The loan is insured by the federal government, so it is only underwritten once. If the loan is approved by the lender, it automatically gets approved for mortgage insurance.
• The standard down payment amount is 3.5% of the purchase price. If the borrower makes a full price offer on a HUD home, then the down payment is only $100.
• The borrower can get a gift or a loan from a relative to pay for the entire down payment.
• The guidelines are the same for all FHA loans, regardless of whether the property is in a declining market or not.
• Interest rates are the same for everyone with a credit score above 660. They go up slightly for people with scores between 620-659.
• Reserves are not required and collection accounts do not need to be paid.

Conventional loans:
• The loan is insured by a private mortgage insurance company, so it gets underwritten twice - once by the lender and again by the mortgage insurance company. The stricter guidelines are almost always from the mortgage insurance company.
• The standard down payment is 5% for first-time home buyers. If the property is in a declining market, the mortgage insurance guidelines may require an additional 5% down for people who are not first-time home buyers.
• The borrower can get a gift from a relative, but they must have at least 5% of the purchase price from their own funds. However, if a relative gives a gift of 20% of the purchase price, then the borrower doesn't need any money at all from their own funds.
• Everyone with a credit score above 720 gets the best rates. For every 20 points below 720, the rates go up.
• The mortgage insurance companies SOMETIMES require the borrower to have reserves and to pay collection accounts. (Do NOT advise anyone to pay collection accounts until their loan has been run through Fannie Mae's or Freddie Mac's online underwriting systems, because paying old collection accounts will lower their credit scores and they may not get approved.)

This may make it look like FHA loans are superior to conventional loans. They are - but only for some borrowers. For other borrowers, a conventional loan is better. The way to tell is to fully qualify the borrower, determine what their financial goals are, and only then recommend a particular loan.

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