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Introduction

When it comes to buying a home, securing the right mortgage is a critical decision that can significantly impact your financial future. Two popular options for financing a home purchase are conventional loans and FHA loans. Each has its own set of advantages and disadvantages, making it essential to understand their differences, eligibility requirements, and what they can offer to potential homeowners.

Conventional Loans

Conventional loans are traditional mortgage loans that are not backed or insured by a government entity. They are typically offered by private lenders, including banks, credit unions, and mortgage brokers. Conventional loans are usually sold to either Fannie Mae or Freddie Mac. Here are some of the pros and cons of conventional loans:

Pros of Conventional Loans:

1. Flexible Terms: Conventional loans offer a wide range of loan terms, allowing borrowers to select the one that best suits their financial situation. You can choose between fixed-rate and adjustable-rate mortgages, and terms can vary from 15 to 30 years.
   
2. Down Payment Options: You have down payment options that start with 3% down for first time homebuyers to more than 50% down payment if you have the money. Step up buyers will need at least 5% down payment, and you can buy a 2-4 unit property for as little as 5% down.
   
3. Lower Costs for Borrowers: If you have a good credit score, 3-5% down payment, and not too much debt, you may qualify for competitive interest rates and lower fees, ultimately saving you money over the life of the loan. There is no upfront private mortgage insurance (PMI), and monthly PMI is lower for solid credit scores.
   
4. No Mortgage Insurance: Conventional loans do not require PMI if you make a down payment of at least 20% of the home’s purchase price. This can save you money on your monthly mortgage payments. If you must pay PMI when you purchase the home, you can have it removed once your equity is greater than or equal to 20% for a single-family home.
   
5. No Property Restrictions: Conventional loans can be used to finance a wide range of properties from single-family homes to condos to multi-unit properties. You can get a conventional mortgage to buy your primary residence (where you live), an investment property and even a second home.
   
6. Access for Most Borrowers: You can qualify for a conventional loan if your credit score is as low as 620. Borrowers who have higher monthly debt and delinquencies can also qualify for a conventional loan. In these cases, you may need mitigating circumstances to qualify for a conventional loan. It is best to speak with you Lakeside Bank mortgage loan consultant to see what is best for you.

Cons of Conventional Loans

1. Stricter Eligibility Criteria: Conventional loans typically have more stringent credit score and debt-to-income ratio requirements compared to FHA loans. Borrowers with less-than-stellar credit may find it challenging to secure a conventional loan. It is best to speak with you Lakeside Bank mortgage loan consultant to see what is best for you.
   
2. Larger Down Payment: While conventional loans allow for down payments as low as 3%, a higher down payment is often required to avoid PMI or secure favorable terms. This can be a significant barrier for some buyers.
   
3. Limited Government Assistance: Unlike FHA loans, conventional loans do not offer as many government-backed assistance programs for down payment and closing cost support. Speak to your Lakeside Bank mortgage loan consultant to find out what down payment assistance programs can be used by you for either an FHA or conventional loan.

FHA Loans

FHA loans are government-backed mortgages insured by the Federal Housing Administration. These loans are designed to make homeownership more accessible to a broader range of borrowers, including those with less-than-perfect credit histories. If you are struggling to qualify for a mortgage to buy a home, FHA could be a great way to go. You can compare both FHA and conventional mortgage options side by side and see what is best for you.

Pros of FHA Loans

1. Lower Down Payment Requirements: FHA loans are known for their low down payment requirement of 3.5% of the purchase price. The down payment is 3.5% for a condo, single-family home or 2-4 unit building if you live there. This makes homeownership more attainable for those who may not have substantial savings.
   
2. Easier Qualification: FHA loans are more accessible to borrowers with lower credit scores and a less favorable credit history. If you have a credit score in the 500s, you may still qualify for an FHA loan. This flexibility in qualification criteria can open doors for potential homeowners who might not qualify for a conventional loan.
   
3. Competitive Interest Rates: FHA loans often offer competitive interest rates which can help you get a lower down payment. Sometimes the FHA interest rate is lower than a comparable rate for a conventional loan. Make sure you compare the two of them with your Lakeside Bank mortgage loan consultant.
   
4. Government Backing: The FHA insures lenders against losses, providing them with more confidence to lend to a wider range of borrowers. This government backing reduces risk for lenders and helps borrowers obtain better loan terms.

Cons of FHA Loans

1. Mortgage Insurance Premium (MIP): FHA loans require both an upfront mortgage insurance premium (UFMIP) and an annual mortgage insurance premium (MIP), which can increase the overall cost of the loan. MIP payments may be required for the life of the loan depending on the program. If you have very good or excellent credit, the MIP is the same as if you had terrible credit. Unlike a conventional loan, there is no mortgage insurance benefit for good credit.
   
2. Property Restrictions: Getting an FHA loan for a condo can be very challenging because all condo buildings must be FHA approved. FHA condo approvals expire after only two years so make sure that the building has a current approval. Many lenders, including Lakeside Bank, offer spot approvals if the building is not already FHA approved. This can be challenging if the property manager, HOA Board and/or seller’s realtor do not want to cooperate with the spot approval.
   
3. Lower Loan Amounts: FHA loan limits vary by location and are lower than the loan limits for conventional loans. Depending on your home budget, this may not be an issue. You need to keep an eye on the maximum FHA loan amount in your area so that you will qualify for the loan.
   
4. Sustainability Test: For three- and four-unit buildings, 75% of all rental income (including the unit that you will live in) must be greater or equal to the housing payment. You may not have trouble passing the test, but it is just another thing to think about that is not relevant for a 5% down payment conventional loan for a 3-4 unit.
   
5. Challenging Appraisals: FHA appraisals may have stricter requirements than a conventional appraisal. Most of the issues arise around safety. Most common FHA appraisal issues are chipped paint on an outside porch or a broken step in a walkway. These items can be easily repaired by the seller. Other items that come up in an FHA appraisal are a nonconforming in-law unit or bathroom that is not 100% enclosed. Unfortunately, sellers of properties that have these issues (and their realtors) will avoid FHA borrowers.
   
6. People Don’t Understand FHA: There are fewer FHA loans done so there is generally less awareness about the program. Because there is less understanding of the program, many industry professionals including realtors and attorneys will recommend that their clients avoid FHA borrowers. Your offer to buy a home and/or pre-approval letter may be ignored because it is FHA. This is not fair, but it is true. Talk to your realtor and your Lakeside Bank mortgage loan consultant about strategies to make sure that your offer gets approved.

Eligibility for Conventional Loans

Now that we’ve explored the pros and cons of conventional and FHA loans, it’s essential to understand the eligibility criteria for each.

1. Credit Score: A credit score of 620 or higher is typically required for conventional loans. A higher credit score will lead to more favorable terms.
   
2. Down Payment: Conventional loans usually require a down payment of at least 3%, although a 20% down payment is recommended to avoid PMI.
   
3. Debt-to-Income Ratio: Lenders prefer a debt-to-income (DTI) ratio of 43% or lower, but exceptions may be made based on the borrower’s creditworthiness that will push the DTI ratio to just under 50%.
   
4. Employment and Income: Steady employment and sufficient income to cover monthly mortgage payments are necessary.

Eligibility for FHA Loans

1. Credit Score: FHA loans are more lenient and often accept credit scores as low as 500 with a manual underwriting of your mortgage file or 580 with a 3.5% down payment.
   
2. Down Payment: The minimum down payment for an FHA loan is 3.5% of the purchase price, making it an attractive option for those with limited savings. Your terms only improve a little with a higher down payment so there is a real incentive to keep your down payment at 3.5%.
   
3. Debt-to-Income Ratio: The recommended DTI ratio for an FHA loan is around 43%, though exceptions may be made based on circumstances that could push the DTI up above 55%. FHA is a great program for people with higher debt ratios!
   
4. Employment and Income: Borrowers must demonstrate steady employment and sufficient income to support the mortgage.

Conclusion

Choosing between a conventional loan and an FHA loan depends on your individual financial situation and homeownership goals. Conventional loans offer flexibility and potentially lower costs for well-qualified borrowers, while FHA loans provide accessibility and assistance for those with less-than-perfect credit or limited savings.

Ultimately, the decision should be based on a thorough assessment of your credit score, down payment savings, and your ability to meet the eligibility criteria. It’s also wise to consult with your Lakeside Bank mortgage loan consultant to make an informed choice that aligns with your financial objectives and lifestyle. Your Lakeside banker can show you rates, mortgage insurance cost, payments and closing costs side-by-side so that you can pick what is best for your financial situation. By weighing the pros and cons of each loan type and understanding the eligibility criteria, you can take a significant step toward realizing your dream of homeownership.