FHA vs Conventional Financing

The FHA has requirements for any loan it insures. The requirements, however, are usually very beneficial to first time or low income buyers. Among the features of an FHA loan are:

Less Rigorous Qualifying Standards
The FHA allows reestablishing of credit a short time after bankruptcy given any judgments and taxes have been paid, or a repayment plan has been established. Conventional lenders usually wait much longer before making loans to individuals after bankruptcy or foreclosure.

Lower Down Payment Requirement
Usually down payment requirements for a FHA loan are around 3%. This is generally less than conventional down payment requirements.

Secondary Financing Cannot be Used Towards a Down Payment
The FHA allows non-refundable gift to help in the down payment. They also accept credit from a purchase or rent agreement as well as improvements made by the buyer as qualifying towards the 3%, these are usually not allowed under conventional financing.

Some Closing Costs are Covered by the Down Payment
In contrast with most conventional loans, the closing costs are completely separate from the down payment

Mortgage Insurance Provided by FHA is Required
The FHA requires that borrowers have insurance even if their down payment is 20% or more of the purchase price. This is in contrast to most conventional loans where mortgage insurance is not required if the down payment is 20% or more of the purchase price.

Lenders are Not Allowed to Charge Prepayment Penalties
Some conventional lenders will charge prepayment penalties, for paying back the loan before the entire term is over or a portion of it is over. The FHA forbids such penalties so the loan can be paid off as fast as you want.

The Property Must be Occupied by the Borrower
The FHA does not insure investment properties, while conventional lenders will.

The Loan Amount Must be Within the FHA Loan Limits
The amount of the loan must be at or below the maximum loan limit set by the FHA. Those that exceed this will not qualify for an FHA insured loan. The limit varies depending on state and location.

Lenders are Only Permitted to Charge 1% in Loan Origination fees
The origination fee is usually much less than conventional lenders, however the lender is allowed to charge discount points. These discount points can be paid by the buyer, seller, or a third party.

Lenders are Required to Appraise the Property
The appraisal must occur through an FHA approved appraiser, and major non-cosmetic defects must be reported. Among these are

  • standing water against a foundation
  • integrity of foundation
  • mechanical systems health (plumbing, heating, etc)

The FHA Loans are Fully Assumable
An FHA insured loan can be assumed (transferred from one person to another), unlike some conventional loans. The assumption will not cause an increase in interest rates, however they are not assumable by investors.

An FHA insured loan generally favors low income and first time buyers. Although other buyers can qualify for an FHA insured loan, conventional lending may offer similar or better terms. Be sure to compared both FHA insured mortgages and conventional mortgages before making a decision.

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