September 19, 2022
Which is better, a conventional mortgage or an FHA home loan? If you are struggling to make this choice, rising interest rates and home ownership costs might make you look twice at your upfront costs and other expenses associated with each type of mortgage loan.
The more forgiving credit requirements and down payment expectations of an FHA mortgage may have you thinking twice about going conventional.
When it comes to FICO scores, FHA loans on paper are easier to be approved for than conventional home loans. And while a conventional mortgage could be more affordable over the lifetime of the mortgage, those who need more flexible credit requirements and lower upfront costs may find the FHA mortgage worth considering.
There are a few objections to FHA loans. Some are less of a sticking point when home loan costs are on the rise. If you need to save more money on the front end of your loan, the FHA mortgage option could help.
Saving on the upfront costs is not a priority for all borrowers and a common objection to using an FHA mortgage is that FHA loans require mortgage insurance for either 11 years or the lifetime of the loan, depending on the loan.
It is true that a conventional mortgage or construction loan would permit you to make a larger down payment to get rid of the mortgage insurance requirement. But how much?
For conventional mortgages, you will typically pay 20% down to avoid paying a mortgage insurance premium. Not all lenders charge the same or have identical requirements.
Why wouldn’t you want to buy your way out of mortgage insurance? For some, paying 20% down up front on a property with $250,000 doesn’t make as much financial sense from the standpoint of reduced upfront costs.
Why? Because you may only be required to pay $100 a month (this is an example only) for that mortgage insurance.
If you are planning to refinance later on you may be able to get rid of mortgage insurance that way. If saving more money up front is your goal, paying that 20% down on a conventional loan might not be the best move.
There are other advantages to having an FHA mortgage.
For example, you cannot be forced to close the deal or even forfeit earnest money with an FHA loan if the house appraised lower than the asking price. FHA loan rules forbid you from being placed in such a position.
HUD 4000.1, the FHA Single-Family Lender’s Handbook, says for FHA loans earnest money must be returned if the borrower walks away from a sale where the seller asks for more than the appraised value.
Some want to know if it’s possible in such cases to renegotiate or just buy the home anyway. The answer is yes but be ready to pay the difference between the appraised value and the asking price in cash. You cannot finance that amount.
The same rules may or may not apply for conventional loans; much depends on lender standards.