Conventional loans can be a great option for homebuyers, but before settling on this particular form of financing, do yourself a favor and comb through the pros and cons before making a move. It is easy to get excited while house hunting, but it’s best to stay grounded when determining lending options. Let Ruoff walk you through a few factors to consider before signing on the dotted line for your next home loan.
Riskier than mortgages backed by the US government, conventional loans typically hold borrowers to a higher standard. Better credit scores are required as the financial institution assumes all the risk of buyer default. While FHA loans can be approved for folks with credit scores reaching as low as 500, with a conventional loan the requirements are much more stringent. 620 to 640 usually serves as the standard to insure eligibility. For borrowers unable to put down a full 20 percent, the credit requirements may well reach even higher as the PMI company often mandates stricter credit ratings than the bank itself.
For homebuyers with average to low credit scores or marks on their borrowing history, an FHA loan could be the better route to take. Bankruptcies and past foreclosures are forgiven much faster with a government-backed mortgage, whereas a conventional one will require a longer waiting period or may not end in loan approval at all. It should also be mentioned that FHA loans tend to allow for higher DTI than conventional ones, so property seekers with debt-to-income ratios above 45 percent may want to take this into account.
Conventional loans require larger down payments, ranging anywhere from 10-20 percent. Borrowers unable to meet these thresholds might benefit from looking toward FHA lending instead. With an FHA loan, down payments can reach as low as 3.5 percent, a huge perk for first-time buyers or folks finding themselves in high-dollar real estate markets.
Should borrowers fall under 20 percent on their down payment, mortgage insurance will be required regardless of who holds the loan. Private mortgage insurance (PMI) is mandated on most conventional loans until 20 percent of the home’s value has been accumulated in equity. For FHA loans, however, Mortgage insurance premium (MIP) is required regardless of the size of the down payment. For this reason, borrowers who are able to produce at least 20 percent may prefer to work with a conventional loan.
Conventional loans also come with increased options such as higher loan limits and more flexible terms. Additionally, those wishing to pay their home insurance and property taxes directly can sometimes do so under a conventional loan, while FHA lending requires homeowners to keep these funds in an escrow account. People wishing for added flexibility in their monthly mortgage payments may find the decision to pay these additional costs on their own to be a key advantage.
Another perk of a conventional loan comes into play during closing. This type of financing is known to close much quicker than government-backed loans. First, FHA home inspections are notoriously nit-picky, often requiring additional repairs and time. Secondly, with a conventional loan, the entire approval process can usually be done in-house, cutting the time to close. With a loan backed by the government, paperwork must be sent off to additional agencies for review and approval which obviously prolongs the duration.
An FHA loan does have its advantages, though, when it comes time to close. Closing costs on a conventional loan must be paid upon signing and cannot be rolled into the payment like with an FHA mortgage. Conventional lending may also tack on additional fees, so buyers need to be confident in their cash reserves in order to seal the deal.
On top of all the pluses and minuses surrounding conventional loans, the most compelling reason to strongly consider one really hinges on the property seller’s perspective. It has been proven time and again that sellers tend to prefer conventional loans. Homebuyers who find themselves in a bidding war might want to take an edge over the competition and settle on a conventional loan, providing they are able to meet the tougher criteria.
Homebuyers have a multitude of factors to consider when pulling the trigger on a new property, but the means by which they will find financing is one of their most substantial decisions. Taking an honest look at one’s current credit profile, available cash on hand, desired timeframe, and potential competition will help house hunters hone in on the type of lending that best suits their individual situation. For some, it might just be a conventional loan, while others will find success with alternative mortgage products.
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