Real Estate Loans: FHA vs. Conventional Loans

In the last blog post I discussed the concept of obtaining enough cash flow to cover your monthly overhead expenses. This is the point at which you can quit your job and become an asset manager. Let’s talk about what the most common types of cash flow producing assets are: real estate, owning equity in a business, dividend distributions derived from stock portfolios, and interest from bond returns.

I will discuss each of these topics at length in future blog posts, and will start with real estate first (specifically residential real estate). Real estate is divided in to two main categories, commercial and residential. Typically, the first property an individual will purchase is a primary residence. There are three main categories of loans: FHA, VA, and a Conventional loan.

Keys.jpg

For this blog post, I will be discussing the difference between FHA and conventional loans. An FHA (Federal Housing Administration) loan is a mortgage that meets certain federal guidelines and is backed (insured) by the government. The loan is usually purchased by a government entity such as Fannie Mae or Freddie Mac. An individual usually obtains a loan from an MLO (Mortgage Lending Officer), through an approved FHA provider. For example, an individual goes to their bank (like Wells Fargo or their local credit union) and obtains a loan. Once the purchase of the property is complete, the bank will sell that loan to a federal government agency (Fannie Mae/Freddie Mac).

An FHA loan can only be used to purchase a primary residence, and requires a minimal 3.5% down payment. A conventional loan requires a higher down payment, and has slightly stricter requirements. One might ask, “Why would I apply for a conventional loan, when I can put less money down on an FHA loan?”. One reason is that sellers prefer conventional loan buyers. This is because FHA loans require that the home meet certain minimum standards (some examples are: the house must have a stove, the water heater must have earthquake proof straps, the buyer must be purchasing the home as their primary residence, etc.).

Another reason why sellers prefer conventional loans over FHA loans, is that they believe that the buyer has stronger financials. All loans require an appraisal, and the lender will only lend up to the amount that the home appraises for. In an inclining market, where demand is high and there is an inventory shortage, a house may not appraise. The buyer and seller will either have to re-negotiate the purchase price, the home will fall out of escrow (no agreement is made), or the buyer will have to pay the gap (come up with the difference between the appraised value and the contract price).

In a later blog, I will discuss the importance of using higher LTV (Loan To Value) conventional loans to purchase an owner occupied home, and then turn it into an income producing property. The goal of this blog is to explain how to understand and win the financial game in terms that everyone can understand. For now, if you have any questions about the material that I have written about or want to know more about a specific topic, post a comment below and I will write a blog post about it!

 

Photo Credit For Keys in Door Picture

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