If you’re looking to purchase a home for the first time or refinance your loan, you might be faced with the dilemma of choosing between an FHA loan and a conventional loan. Before you go ahead with any of these, you should exactly know what each option entails.

What Is an FHA Loan?

An FHA loan is a loan issued by financial institutions that are insured by the US Department of Housing and Urban Development (HUD). This insurance represents the security that lenders seek when issuing a risky loan. However, it requires buyers to pay an upfront mortgage insurance premium of 1.75% upon closing that is rolled into the loan.

This means that buyers will then make monthly payments for their mortgage insurance spread across the life of the FHA. These payments may be canceled after eleven years if the down payment made was 10% or more. The minimum down payment for FHA loans is 3.5%, and a minimum credit score of 580 is required to qualify for the loan.

The common scenario for FHA loans is that a homebuyer obtains a 30-year FHA loan with 3.5% down payment and pays 0.85% of mortgage insurance premium on the borrowed amount per year, or $71 every month for every $100 borrowed.

What Is a Conventional loan?

A conventional loan is a low down payment option for mortgage borrowers. The latest version of conventional loans allows 30-year mortgages of a fixed rate at a minimum of 3% down payment. You typically need a minimum credit score of 620 to qualify for a conventional loan.

You will need to make monthly payments if the down payment is less than 20%. If it is over 20%, they can be canceled when the loan-to-value becomes 80%.

Choosing the Right Type of Loan for You

There are certain factors that need to be considered when deciding which type of loan to go for. As the most obvious one, if you have a poor credit history or limited down payment, you may only have the FHA option available. Likewise, the down payment options for the choices are another factor. If you have limited cash available for making a down payment, a conventional loan is a more feasible option as some lenders offer loans for as low as 3% down payment.

The amount of time you plan to stay in the home is another crucial factor. The FHA monthly mortgage insurance premium won’t matter much if you pay less than 20% down payment and wish to stay for a short time period. If, however, you wish to stay for no less than 11 years, you’ll have to pay the premium for the full 11 years, regardless of your loan-to-value ratio. This way, you will be able to improve your financial situation and be able to refinance into a conventional option that carries no insurance payments.

If you’re confused about the type of loan you should opt for, click here to request more information from an Alliance member.