Buying a home or refinancing a current mortgage is not as cut and dry as you think. You have many options. Government loans are not just for first-time homebuyers anymore. They are good for many borrowers. Conventional home loans have their own benefits too. How do you decide which one is right for you? Let’s take a look.
Why Conventional Loans Take the Cake
If you asked a handful of people which loan is better, they would say conventional. This is just the common thinking in our society. Conventional means lower interest rates and better terms. It might, but not always be the case, though. It also means PMI with less than 20% down and stricter guidelines. Many people don’t realize that part of it.
They just see advertisements for low conventional rates. They then assume this type of loan is better. What is best is what works for you. If you don’t have the financial history to qualify for a conventional loan, you are not a “bad borrower.” You would just do better with one of the government loans available.
What are Government Loans?
Now let’s look at what government loans offer. There are several options:
- FHA – This program is available to any borrower that qualifies. The credit score, debt ratio, and down payment requirements are more forgiving than conventional programs.
- VA – Only qualifying veterans can use this program. You must serve at least 90 consecutive days during the war or 181 days during peacetime to be eligible. The requirements for this program are fairly simple.
- USDA – This program is for low-income families purchasing or refinancing a rural home.
Each program is backed by the appropriate government program. This means the agency guarantees the loan for the bank. If a borrower defaults, the appropriate agency pays the bank back.
FHA Loans are not for First-Time Homebuyers Only
Another common fallacy is that FHA loans are only for first-time homebuyers. This used to be the case. It’s not today, though. In fact, many people use it because of the low credit requirements. The minimum credit score in most cases is only 580 for this program. This helps borrowers who suffered during the economic downturn secure a mortgage.
The FHA loan does come with a downside, though. You always pay mortgage insurance for the life of the loan. In fact, you pay it twice. There is an upfront mortgage insurance and an annual insurance. The upfront insurance is a one-time fee. The annual insurance is calculated one time a year. They base it on the average outstanding balance of the loan. You can’t remove the insurance when you owe less than 80% of the value of the home either. The only way to drop it is to refinance out of the FHA loan.
Who Does Well with Conventional Loans?
You might wonder who would benefit from a conventional loan. If government loans have fewer restrictions, why bother? Conventional loans do have their benefits, though. First, you don’t pay mortgage insurance for the life of the loan. In fact, if you have 20% to put down on a home, you won’t pay any PMI. Even if you put less than 20% down, you can still cancel the insurance once you owe less than 80% of the value of the home.
The borrowers who do best with conventional loans have the following attributes:
- High credit score (over 680)
- Low debt ratio (around 28/36)
- Solid credit history
- Decent down payment
- No special circumstances, such as recent bankruptcies or foreclosures
There are many borrowers who start with a government loan and refinance into a conventional loan. The government loans give them a chance to become a homeowner. They focus on making their mortgage payments on time. They also build up equity. They are then in better standing for a conventional loan. It’s like having the best of both worlds.
Compare the Rates and Fees
Honestly, what it comes down to is comparing the rates and fees you will be charged. You should also look at the term of the loan. If you are able to secure a conventional loan but only as an adjustable rate, you may want to look at your options. Government loans may offer you the stability you need as ARMs can be hard to afford when they adjust.
Look at the big picture. Compare the rates and the fees. Look at the APR. Consider what the loan will cost you over its term. How long will you stay in the home? If this is a long-term home for you, find the most affordable loan. Don’t overpay on the interest rate, but watch the fees. If the home is just for the short-term, you may pay a higher interest rate but have fewer fees. You will only own the home for a short time.
Really there is no answer whether government loans or conventional loans are better. It depends on your circumstances. Look at what you qualify for and compare the loans side-by-side. Consider the mortgage insurance and whether you must pay it for the life of the loan. Look at the fees and how much the loan will cost you over the entire term.
Ask to see both options, assuming you qualify for both. This way you can make an informed decision. Just assuming conventional is better than government or vice versa doesn’t work. Instead, you must look at how the loan pertains to your situation.
Don’t worry if things change – you always have the option to refinance. Just make sure you make your payments on time and don’t get in over your head. If a government loan is the only way to buy a home, take advantage. Just work hard to get the balance paid down and for your credit to improve. This way in a few years you can refinance into the conventional loan. You can then eliminate the mortgage insurance you don’t want to pay.