The mortgage meltdown that led to the housing crisis of 2008 taught lenders and borrowers to proceed with caution. Lenders tightened conventional loan standards, while the Federal Housing Administration extended efforts to make loans more widely available. Cost, qualifying restrictions and accessibility distinguish conventional loans from FHA-insured mortgages. As a borrower, compare the advantages and drawbacks of each loan type before selecting the one that's right for you.
Conventional loans are the most traditional form of financing a home purchase or refinance. Mortgage lenders use standards set by government-sponsored enterprises Fannie Mae and Freddie Mac, but the loans are not backed by the federal government. In contrast, the Federal Housing Administration insures loans, promising to repay lenders if borrowers default. Lenders must adhere to standards set by the Department of Housing and Urban Development, which oversees HUD, in exchange for the government insurance guarantee.
Conventional lenders require a higher down payment or more equity in the home, which determines the loan-to-value. The LTV ratio represents the percentage of a home's value that is financed. Conventional loans require a minimum 5 percent down, or 95 percent LTV; FHA loans require 3.5 percent down, or 96.5 percent LTV. Conventional loans with more than an 80 percent LTV require private mortgage insurance, or PMI, which protects the lender against default. FHA loans require government mortgage insurance, or MI, to protect lenders. In general, MI is more expensive than PMI.
FHA loans tend to have more restrictions in terms of lending limits and property condition standards. It requires an interior and exterior home inspection as part of the appraisal, or home valuation process. Only FHA-approved appraisers may conduct the inspection, and they must report defects to the lender. The FHA lender may require repair of items at their discretion, which must be completed to lender satisfaction before the close of escrow. Conventional loans also require an appraisal, but the inspection portion is less stringent.
FHA loans are available only through lenders that have prior HUD approval to participate in its programs. It imposes national loan limits based on local median home prices, which range at a maximum of $271,050 in most areas to $729,750 in the most expensive areas. Conventional loans are offered by all mortgage-lending institutions. Loan sizes range from conforming, $417,000 or less, to jumbo non-conforming, which can reach several millions of dollars.
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