FHA loans, conventional loans, VA loans, jumbo loans, USDA loans ... how's anyone outside the mortgage industry supposed to tell all these apart? Read on for some key differences, but first let's look more closely at mortgages backed by the Federal Housing Administration (FHA) to see when they're a smart choice – and when a different type of loan would be better.
When to Choose an FHA Loan
When are you best off with an FHA loan? The answer to that couldn't be easier: When you can't get another type. Maybe there are exceptions to that, but it's hard to think what they might be.
The fact is you're more likely to get approved for an FHA-backed product than other mortgages – except VA loans, which are almost always the best choice for those who are eligible, and USDA/RHS loans, which are only for people with modest incomes who live in selected rural areas. Although you're still going to have to show you're a responsible borrower, if you have a small down payment (3.5 percent or more of the purchase price) and an unimpressive credit score (below 660, according to some experts), the FHA may be your only chance of qualifying for a loan. But it will cost you.
Why FHA Products Are a Last Resort
The big disadvantage with FHA products is all about three little letters: they come with MIP rather than PMI. MIP stands for mortgage insurance premium, and you have to pay some of that on closing (though you can usually roll it up within the loan), and then the rest every single month until you've paid down the mortgage to zero – or have refinanced or moved homes. And that's a big extra expense compared with other types of mortgages.
True, you have to pay PMI (private mortgage insurance) premiums each month if you have a conventional loan but don't have a down payment of 20 percent or more of your new home's purchase price. But PMI is different from MIP in that you can stop making those monthly payments when the value of the home reaches 20 percent of your mortgage balance. That can happen because you've paid down that much, because the property has increased in value to that extent, or because those two together have combined to get you to that magic 20 percent. Many homeowners find themselves free of PMI payments within two or three years of buying their homes, which potentially can save them many thousands compared to those with MIP. For more information, see How To Avoid Private Mortgage Insurance.
How FHA Mortgages Can Still Make Good Sense
Of course, MIP may well be a price worth paying. If you're desperate to get onto, or stay on, the property ladder – especially if you're buying in an area with rapidly increasing home prices – then it can make good financial sense to choose an FHA mortgage.
That's especially true if you use the time you have to improve your credit score. Then you can refinance into a conventional loan with a better mortgage rate (as long as those don't rise overall) and the prospect of few or zero PMI payments, depending on your mortgage balance and the value of your home when you do so.
It's important to note that FHA-backed mortgages come with caps on the amount you can borrow, and these vary from area to area. To discover the maximum loan available where you want to buy, use the search engine on this government website.
Different Types of Mortgages
Money for mortgages all comes from private lenders. However, the federal government protects those lenders from loss when it guarantees three categories of loans:
- FHA loans – Mostly for first-time buyers and past and existing homeowners whose credit scores and down payment resources might otherwise bar them from getting a mortgage
- VA loans – For qualifying past and present members of the military, and sometimes their widows and widowers
- USDA/RHS Loans – These are offered by the Rural Housing Service (part of the U.S. Department of Agriculture) to people in certain rural locations who have low or close-to-average incomes for their area
Conventional loans are those that lenders can sell on to Freddie Mac and Fannie Mae because they conform to those organizations' lending rules. The most important of these rules (or "underwriting guidelines," to use the jargon) concerns the size of the loan, which is currently capped for single-family homes at $417,000 everywhere other than Alaska, Hawaii, Guam and the U.S. Virgin Islands, where it's $625,500. Freddie and Fannie are "government-sponsored enterprises," which buy and sell mortgages and their related securities on secondary markets.
If you want to borrow more than Fannie and Freddie allow, you'll need a jumbo mortgage, so called, obviously, because they're big. These involve the lender risking more of its own money, so borrowers usually need a hefty down payment and great credit to qualify.
Once you've decided on the type of loan that suits you best, you have to choose whether you want a fixed-rate mortgage or an adjustable-rate mortgage (ARM). Nearly everyone correctly wants the former, but it's worth considering the latter, especially if you're not planning to stay in your new home for longer than seven years or so.
Picking the right sort of mortgage for your particular needs is an essential first step when you're shopping for a loan. Most people quickly identify the one that suits them best, but if your circumstances make choosing difficult, why not use the LendingTree Ask the Loan Officer service? Just post your question (it can be on any loan topic) on the web page, and wait for an expert to respond with free, no-obligation advice tailored for you.