Not all mortgages are created equal. Aside from more apparent differences between 30-year variable, 15-year fixed, balloon payments, and more, there are two separate categories of mortgages that are distinct from one another we’ll discuss in this article.

Private Mortgages

Banks and private lenders will always protect themselves and place their interests first by not lending to prospective homeowners they see as a poor risk. How each lender defines a “poor risk” can vary, but for the most part, anybody with a 619 credit score or less is a risker potential borrower. Income level, previous loan history, and housing history also factor into the lender’s decision when considering a potential borrower’s application for a loan. Though it may feel counterintuitive, the less a person needs the loan, the more likely the bank will provide the money.

FHA Loans

FHA loans, or mortgages from the Federal Housing Administration, are more easily accessible than private mortgages. However, they usually come with higher interest rates because of their accessibility. President Franklin Roosevelt created the Federal Housing Administration to respond to the financial hardship that fell on many people during the Great Depression. Thousands of Americans were at risk of losing their homes or had already had their houses foreclosed on, creating a dire need for a relief program that helped people with bad credit and no money, that had no hope of qualifying for loans, remain housed.

The FHA facilitated loans to these people in desperate times and helped ensure their debt. This program ultimately improved the overall confidence of U.S. consumers, which helped combat the lack thereof that aided in the economic devastation during the Great Depression. In modern times, the FHA oversees providing loans to people with a credit score of 500 or above.

There are tiers in how much a person must put down up front based on their credit score. The borrow must put ten percent down if their credit score is between 500-579. If it’s between 580-619, they can put down five percent. This is typically more than a person would have to put down in a standard mortgage loan from a private lender or bank, as they might be able to put down as little as three percent.

The Insurance Difference

There are three main differences between mortgages from a private lender or a mortgage from the FHA:

  1. If the homeowner has 20 percent equity or less in their home, standard mortgage loans require the borrower to have PMI or personal mortgage insurance.

  2. As standard mortgages usually only require the borrower to have PMI, FHA loans require two types of insurance: MIP, mortgage insurance premium, and upfront mortgage insurance premium, or UFMIP.

  3. FHA insurance is not directly tied to the borrower’s credit score, unlike PMI.

FHA insurance isn’t affected by a borrower's debt-to-income ratio and is the same cost regardless of the person’s circumstance, but it is more expensive than personal mortgage insurance. However, though PMI is less costly, it isn’t available to people with a credit score of 620 or lower. The cost of PMI also rises dependent on a person’s credit score. If the borrower’s credit score is between 620-680, PMI will cost more. FHA borrowers are not allowed to cancel their PMI insurance under any circumstance, compared to a person with a standard mortgage who can cancel their PMI before the expiration of the term.

In both circumstances, for standard mortgages and FHA loans, the insurance you have to purchase ultimately protects the lender over the borrower. In the case of a default, the insurance ensures the lender gets paid. Though FHA loans are distributed through a government program, the money still comes from private lenders. Having FHA insurance in place allows for more flexibility for the private lenders to provide loans to people they consider riskier, like those with poor credit scores. It protects them from significant losses.

The Final Word

It’s very important to research and know the pros and cons of each kind of mortgage before one borrows money to purchase a home. FHA loans may not be necessary if a borrower has solid income, good credit, and positive payment history. Everyone is different, and it is to the borrower's benefit to consider their options before taking action and signing onto a mortgage loan.