Today in this video, we’re going to talk about an FHA loan versus a conventional loan. What are they what is the difference in which loan is best for you? Check it out.
Hi, my name is Rhonda Burgess and I’m a real estate broker and mortgage underwriter here in Nashville, Tennessee, and my firm is Southern Living Realty Partners. You know, something I realized is I do a lot of talking about the different types of loans and a lot of people don’t know the difference between the different type of mortgage loans that you can get. So I want to do a quick video to talk about the difference between an FHA loan and a conventional loan so that we clear up a lot of the misconceptions.
And a lot of people use the terms interchangeably, but they are actually two totally different loan products.
Please consider subscribing to the channel and give this video a thumbs up. OK, so first, on an FHA loan, an FHA loan is a loan that is backed by the government, you are not getting a loan from the government, but it is backed by the government, the Federal Housing Administration FHA. It is administered by the housing and urban development part of the government. What it is, is that you will still get a loan from a lender, from a bank, from a lending institution, and the government insures that loan.
There is a mortgage insurance premium. There’s an upfront mortgage insurance premium, plus there is a monthly premium that you will pay. So there’s a lump sum of mortgage insurance premium that you pay upfront when you close on an FHA loan.
Plus, there is a monthly mortgage insurance premium that you pay. This pays for that insurance policy that ensures that if you go back on that loan, meaning you go into foreclosure, you do not pay your mortgage. The lender can go to the government. They have this insurance policy against you that you pay for every month. And the lender can go to the government and say, hey, I want to I need this loan went bad, so I need my money back.
And so then the government normally insures FHA loans for 85 percent. So, for example, if your mortgage is one hundred thousand and you go into default and you are foreclosed on, normally the lender will be paid back eighty five thousand of that hundred thousand by FHA. So it is insured by the government, but it is not a loan you’re getting directly from the government on an FHA loan. We have two ratios, we have a front end and a back end ratio.
Normally your front end ratio, which is your housing expense, can only be 29% of your income. Your housing expense is your principal and interest your taxes and your homeowner’s insurance as well as your mortgage insurance premium. All five of those added together cannot be any more than 29% of your of your income, of your gross income. This is your gross before taxes. FHA also has a back end ratio of 41% normally, and that fluctuates but normally it’s 41% meaning that your housing expense plus the minimum payments on all of your debts cannot be no more than 41% of your gross income.
FHA, just like conventional, has an automated underwriting system. On an FHA, if you have strong compensating factors, I have seen that 41% be higher. I’ve seen that 29% be higher. Compensating factors. You need a high credit score. That’s a compensating factor. You’ve been on your job a long time. That’s a compensating factor. If you have money left after closing, meaning after you pay whatever down payment after you’ve paid your closing costs, you have months in reserves. You have money in a in an account somewhere where you would be able to pay your mortgage payment. And that amount of reserves is more than two months, two months worth of payments. That is a compensating factor. So for an FHA, right now you need a 660 or higher. FHA loans do not really have a minimum credit score. But as I discussed in a previous video, the lenders, the people who you actually get the money from do have a minimum credit score.
So you really need to be looking at a 660 score higher to get the best interest rates. On both loans, you will have to have homeowner’s insurance. This is totally different from the mortgage insurance that I just talked about. The homeowner’s insurance is where it covers your house in case something happens, your house is struck by lightning, your house catches on fire. That’s homeowner’s insurance. That is totally different from mortgage insurance, no matter how much you pay down your loan.
You will always have homeowner’s insurance, even if you pay off your house, you should have homeowner’s insurance to insure if something happens to your house, just like you have car insurance, whether you pay, whether your car is paid for or not, you should at least have some liability coverage on when you when it comes to owning a home.
You should keep homeowner’s insurance on your house. When you get to below 80 percent loan to value, your mortgage insurance can be dropped. You have to ask the lender if you if you started off, let’s say, at 97% percent and now you’ve paid it down to 80 percent, 79 percent, then you can ask your lender for your mortgage insurance premium to be removed.
But mortgage insurance premium is standard on any loan when you are above 80 percent LTV.
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On an FHA loan, normally you have to put 3.5% percent down of the purchase price. On an FHA loan, also, there are several grants and different programs that will pay the 3.5% percent for you. On an FHA loan, the seller of the house can pay up to 6% percent of your closing costs and prepaids. Your pre-paids are things like prepaid interest and your homeowner’s insurance. OK, so you can get help on an FHA loan for the down payment and the seller can help you on the closing costs and they can contribute up to 6% percent.
Now, on a conventional loan, a conventional loan normally requires at least 5 percent down. These are going to be your Fannie Mae and Freddie Mac programs. You hear those names thrown around a lot. Those are conventional loans from Fannie Mae and Freddie Mac. They are not government entities. They are not. But they handle the majority, the bulk of all of our mortgage products. OK, so they’re like a quasi government agency. Conventional loans also require mortgage insurance.
They require mortgage insurance if you are above 80 percent LTV. Normally on your conventional loans, your ratios, you don’t normally have a front end ratio, meaning you don’t have a housing expense ratio, but you will have a total debt to income ratio. Normally on a conventional, they start at 38% percent on the back end ratio. But I have seen many conventional loans that will have a much higher debt to income ratio, a much higher total, total debt to income ratio, depending on the compensating factors that you have.
Conventional loans are run through an automated underwriting system as well, just like FHA. So, again, if you have compensating factors, you have reserves. after closing. You’re putting down a larger down payment. You have a higher credit score. Then yes, a lot of times your debt to income can be higher with those compensating factors. The rates on an FHA loan compared to a conventional loan are essentially the same, FHA may have a little different pricing, but still they’re going to be in the same in the same ballpark.
So if you’re looking at 3% percent unconventional, you’re looking at 3% percent, 3.5% percent on FHA. There’s really not that big of a difference. The difference really conventional – it just requires more money down. More first time buyers use the FHA loan because they can get assistance for those for that down payment and everything using an FHA loan. For either loan, an FHA loan or conventional loan, you can do a 15 year, you can do a 30, you can do a 20 year, you can do a 25. Most people because buying a house is such a large expense, most people do a 30 year loan, but you are free to do a 15 year. There are also adjustable rate loans for FHA as well as for conventional. So it may be that you start off with a super low rate for two or three years or even a one year. We have one year arms, one year adjustable rate mortgages. You can do a one year arm, which may start you off below market rate, but that interest rate can adjust, it can go up, it could stay the same. But nine times out of 10, it’s going to go up.
So you do have the option with either FHA or a conventional loan to do an adjustable rate mortgage. But most people opt for either a 30 year fixed or 15 year fixed rate mortgage where the interest rate does not change.
Again, my name is Rhonda Burgess and I’m a real estate broker and mortgage underwriter here in Nashville, Tennessee. If you need help with finding a house here in Nashville, I would be glad to help you. Please feel free to download the Home Scout app from your App Store and use my code 0832. And that will give you access to all of the Nashville MLS listings and the listings are updated every 15 minutes. Thank you again. And as always, have a blessed day.