Differences Between an FHA and a Non-FHA Home Loan

Consider the advantages and disadvantages of an FHA loan before choosing a new mortgage.

Consider the advantages and disadvantages of an FHA loan before choosing a new mortgage.

If you are in the market for a new home and need a mortgage to finance it, you are probably overwhelmed by the wide selection of lenders and mortgage types available. An important decision -- which may narrow your range of options -- is whether to choose an FHA loan or a non-FHA loan. The Federal Housing Administration provides mortgage insurance for loans made by its approved lenders to protect them against the possibility that homeowners will defaulting on their loans. An FHA-insured loan, however, might or might not be your best means of financing the purchase of a home.

Downpayment

One of the key differences between a conventional loan and one insured by the FHA is size of the required down payment. The FHA insures loans with a down payment as low as 3 percent of the principal, and it allows you to use family members, friends, employers and charities to foot the cost. Non-FHA loans, on the other hand, usually require a much larger down payment and you must prove you alone can make payments.

Interest Rates and Credit Scores

A borrower's credit score reflects the likelihood that she will pay her debts based on her credit history. The FHA covers part of the risk of a mortgage loan default, allowing lenders to approve the loans of buyers with lower credit scores and at lower interest rates. With non-FHA loans, the entire risk falls on lenders, so they generally ask for higher interest rates and are more selective about whom they approve.

Mortgage Insurance

FHA loans and conventional loans both require borrowers to pay for mortgage insurance when the down payment is less than 20 percent of the property's value. The mortgage insurance of an FHA-loan, however, is generally more expensive than that of a comparable non-FHA loan; and unlike conventional loans' mortgage interest, it is not a tax-deductible expense. On the other hand, FHA loans do make it easier to cancel your mortgage insurance once you meet a specified loan-to-value ratio.

Loan Limits

FHA loans are designed to help low- to moderate-income borrowers get into the housing market -- not to finance a vacation home or invest in real estate. To qualify for an FHA loan, the property must be your primary residence and the loan amount must not exceed the limits set by the FHA for your region. Limits are based on the cost of housing in your area. Non-FHA loans are restricted only by the lending requirements of your loan provider.

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