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FHA loans versus conventional loans

FHA loans have typically been the saving grace for potential homeowners who don't have a lot of money for a down payment.

Until recently, the FHA required as little as a 3 percent down and allowed the borrower to roll the 1.5 percent FHA insurance premium into the closing costs.

The FHA even allowed sellers and other organizations to gift the down payment.

When the new housing bill was signed into law in July 2008, some of those loopholes were closed. Borrowers now have to pony up a 3.5 percent down payment to qualify for a loan. In addition, sellers and third-party organizations that financially benefit from the transaction will no longer be allowed to gift the down payment.

"That's the price you pay for the FHA to guarantee that mortgage," says Bob Walters, chief economist at Quicken Loans in Livonia, Mich. "But many people can get FHA loans that could not get a conventional loan," he says.

As lenders restrict access to conventional loans, many borrowers will look to an FHA loan on the path toward homeownership.

If you have the 20 percent down payment required by many lenders today, you may be better off with a conventional loan because you'll gain equity faster and won't have to pay for private mortgage insurance.

FHA loans vs conventional loans
FHA mortgagesConventional mortgages
Pros
  • Lower down payment required.
  • Credit score standards are lower.
  • Mortgage insurance is tax-deductible, subject to income limitations.
  • FHA interest rates are competitive with those of conventional loans.
  • Borrowers who get a conventional loan with 20 percent down build equity faster.
  • No mandated loan limits.
  • Mortgage insurance is tax-deductible, subject to income limitations.
  • Mortgage insurance may come cheaper than for an FHA loan, and take less time to get rid of.
Cons
  • Requires mortgage insurance until 78 percent loan-to-value is reached, vs. 80 percent for conventional mortgages.
  • With lower downpayment required means it builds equity more slowly.
  • FHA loan amounts are capped by the federal government, vary from state to state and are usually lower than can be obtained with a conventional loan.
  • 1.5 percent upfront mortgage insurance premium and ongoing mortgage insurance premiums may end up costing more than private mortgage insurance for a conventional loan.
  • Higher credit score required to qualify, especially in current tight credit market.
  • Larger down payment required.

 

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