Is an FHA or Conventional Loan Your Best Financing Option?

For buyers with sufficient savings or enough other financial resources to pay cash for a home, questions regarding financing may never arise. For everyone else, however, the need or desire to purchase a home comes in lockstep with the ability to find the right financing and successfully navigate the application process.

In America today, the two most commonly used home loan options are the fixed-rate conventional loan offered through banks and traditional lending sources, and the FHA loan, backed by the federal government through the Federal Housing Administration (FHA). 

Understanding the FHA Loan

FHA home loans are available through FHA-approved mortgage lenders on both single and multi-family homes throughout the United States. Because these loans are insured through the Federal Housing Administration, both buyers and the home being purchased must meet certain guidelines for eligibility.

For a home to successfully qualify for an FHA mortgage, it must be in good condition and capable of passing a required FHA appraisal, as part of the underwriting process. FHA appraisals include thorough examinations of both the structure and basic systems of the home, in addition to the grade of the lot where the home is situated to ensure that drainage is adequate to protect the home. In addition, homes must meet safety standards with regards to lead-based paint, and egress options for fire safety, hand rails, etc. 

Buyers who seek to use FHA mortgages must also meet certain eligibility requirements as part of the application process, including satisfactory income and credit scores and an acceptable debt-to-income ratio. Past credit problems typically are not held against applicants, as long as the issue has been remedied and the buyer has brought their credit score back within acceptable limits. Buyers who would like to apply for an FHA mortgage but have credit issues that need to be addressed are advised to consider seeking counseling through an FHA-approved Consumer Credit Counseling program before applying. 

Buyers who get accepted for an FHA home loan may be able to do so with as little as 3.5 percent of the purchase price as a down payment. In addition to small down payment size, FHA home loans may be easier to get approved for than conventional or other types of home loans. This is because the loan is guaranteed through the government's FHA loan guarantee program, which lessens the risk to the lender. One popular misconception about the FHA home loan program is that it is only for first-time buyers. In fact, FHA loans can be used by any buyer who meets the guidelines for the program.

Understanding the Conventional Home Loan

One of the chief differences between the FHA home loan and a conventional one offered by a bank or mortgage broker is the appraisal process. Where FHA appraisals are very concerned with the ability of the home to meet stringent safety guidelines, the typical appraisal used for a conventional loan is solely focused on the market value of the property for which the home loan is being sought. Although condition issues will likely be noted on the appraisal for the conventional loan, they may not require repair before closing, as those noted on an FHA loan would. 

In addition to a market value appraisal, conventional home loans also require a higher down payment with private mortgage insurance (PMI), if applicable. But because some conventional loans can be arranged on a local level through a bank that the buyer has a history with, some types of credit or debt-to-income issues may judged less stringently than FHA loans. It is important to remember, however, that getting the best rate on a conventional loan is easiest with excellent credit. 

To determine which type of loan will be the best one for each specific home-buying situation, buyers should seek the advice of their real estate professional before making a final decision. Because the agent works with a wide variety of lenders and loan programs, they will be able to refer buyers to reputable lenders and help them find information regarding specific home loans.