Friday, September 28, 2012

What is the difference between FHA and conventional loans?

What is the difference between FHA and conventional loans?


Last week I focused on FHA loans. They are great loans, but they are not for everyone. Some buyers prefer a different type of loan called a conventional loan for two reasons. First, FHA loans are geared for the first time buyer or buyer with limited funds; they are not the cheapest loans. Most people do not realize that loans are profitable for banks, and different banks have different loan products. They are even competitive. So, if you are thinking about purchasing a home, I’d look into the loan products different lenders offer. Don’t just shop interest rate, look at fees. That is where you will see big differences.

With all home loans, until you have a certain amount of equity in the property, the lender requires an insurance policy, commonly called PMI, which stands for Private Mortgage Insurance. The buyer pays for it, but it only benefits the lender. It is added onto the monthly payment. With a conventional loan, once you have 20 percent equity in the home, the policy can be removed, but with an FHA loan, the PMI insurance stays on the loan until you have 78 percent equity! That is like paying an extra $100 every month for the next 15 to 20 years, because it will take that long to get 78 percent equity in the property.

Another reason some buyers prefer conventional loans is the interest rate is a little higher on an FHA loan and there are maximum loan amount for an FHA loan. In San Bernardino County, it is $500,000. Interestingly, in other areas, like high end beach communities, the loan amount is $729,000, and in very depressed areas it’s $254,000.

The big difference between a conventional loan and other types of mortgages is the fact a conventional loan is not made by a government entity, nor insured by a government entity. It's what is referred to as a non-GSE loan. A non-government sponsored entity. Types of government loans are FHA and VA loans. An FHA loan is insured by the government and a VA loan Kentucky VA Loan is backed by the government. Buyers shopping for a second home or income property will go with a conventional loan because the homebuyers can take out a conventional loan from a bank, a savings and loan, a credit union or even through a mortgage broker that funds its own loans or brokers them. Two important factors are the term of the loan and the loan-to-value ratio (LTV).

A fully amortized conventional loan is a mortgage in which the same principal and interest payment is paid every month, from the beginning of the loan to the end of the loan. The last payment pays off the loan in full. There is no balloon payment.

Generally, if you are shopping a conventional loan, you will need to come in with a minimal 10 percent down. To avoid paying for private mortgage insurance you can actually get two loans, the first one for 80 percent, then a second for 10 percent. The second loan is usually at a slightly higher rate and shorter term, but you still save by not having the PMI insurance.

Find out if your bank makes special loans to teachers or doctors, as sometimes these types of financing do not demand private mortgage insurance. Of course, you will have to be a teacher or medical professional to qualify for these types of loans.

Whichever loan you are shopping for, I strongly suggest selecting a lender with more than one loan product. The reason is, banks are really neurotic about funding loans these days, even for FHA loans. So, if the first lender declines the loan, which they do for no apparent reason, or the file will sit on someone’s desk waiting for approval for eternity, you can move to the next lender quickly. It is so frustrating when working with one lender, at the end of an escrow, finding out the loan is not going to fund and having to start all over with a new lender. If you select a lender with several loan products, if one lender declines the file, they can quickly move to the next one. Plus you keep working with the loan officer you have established a relationship with.
Getting a home loan is not easy these days. You have your finances open to complete strangers, but it is worth it, especially since the interest rates are incredibly low and so are home prices



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