FHA vs Conventional Loan
If you are thinking about a home loan, you may be wondering which type of loan to get and what type you may qualify for. Two of the most common type of home mortgage for borrows are the FHA and conventional loans. Your first step is understanding the differences between an FHA vs conventional loan before you can decide which is right for you.
What is the difference between an FHA vs conventional loan? The defining difference between an FHA vs conventional loan is that with an FHA loan, the mortgage is insured by the Federal Housing Administration while a conventional loan is not insured by the government.
|Down payment as low as 3.5%||Recommended 20% down payment|
|Includes PMI (Mortgage Insurance)||Usually no PMI (unless down payment <20%)|
|Credit score as low as 500||Credit score of at least 620|
|Debt-to-income ratio 50% or less||Debt-to-income ratio 50% or less|
|Home must be primary residence of borrower||More difficult for average consumer to get|
|Loan limit amount dictated by FHA||Loan limit based on personal finance and credit|
|Strict property standards||More liberal property standards|
There is more to learn about the differences between an FHA vs conventional loan, in terms of how to qualify, how flexible the lending requirements are, how down payment is determined and how much it’s all going to cost you. There is one important thing they share: you should never apply for either of them without doing your research.
What is an FHA loan?
An FHA loan is a government-sponsored home mortgage lending option that is insured by the Federal Housing Administration. The FHA doesn’t actually lend any money; it just guarantees that the lender won’t lose out by insuring it from default.
According to the FHA website, “The Federal Housing Administration (FHA) is the largest mortgage insurer in the world with an active insurance portfolio of over $1.3 trillion.” In short, the FHA assists people in buying houses by backing up the money home buyers borrow from banks.
An FHA loan allows gives greater flexibility all around. Banks can be more generous with mortgages and accept a wider segment of buyers – including those who may not have a perfect financial record or credit history.
An FHA loan also gives more flexibility to home buyers, as it offers the opportunity to some who may have had difficulty buying a home without it.
Here’s a breakdown of the characteristics of an FHA loan and what each means:
|Lower down payment||The FHA insures the mortgage which means the lenders’ risk is minimized, allowing for down payments as low as 3.5%.|
|Flexible lending requirements accept lower credit scores||Another benefit if having the FHA insure the loan is lenders can be more generous with their acceptance of lower credit scores.
The credit score minimums for FHA loans are as follows:
FHA requires a borrower to have:
· a minimum 500 credit score with a 10% down payment
· a minimum 580 credit score with a 3.5% down payment
|Additional expense of FHA Mortgage insurance (MI)||Because the FHA loan allows for a lower down payment than the standard 20 percent, the lender requires insurance in case the borrow defaults on the loan and/or the house must be sold in foreclosure.
There is an upfront mortgage insurance premium and then a monthly payment which can be up to 2% of the original loan amount, per year.
Read ourarticle on FHA mortgage insuranceto see how this is calculated.
The FHA mortgage insurance is paid monthly and is included into the borrower’s mortgage payment.
|May have a lower interest rate||The interest rate on an FHA loan is typically calculated according to their FICO credit score. The higher the FICO score, the lower the interest rate a lender can offer to you. The lower the FICO score, the higher the interest rate may be.
It’s the buyer, not the loan that determines the cost, in the end. Buyers choosing an FHA loan because of a credit score that doesn’t qualify for a conventional loan, or because they need a much lower down payment.
|Overall expenses over the lifetime of loan tend to be higher||With the additional monthly cost of PMI, along with a larger amount of the purchase price financed from the start, borrowers who take out an FHA loan typically pay more over time than those who use a conventional loan.|
|Additional hoops to jump through during approval and loan processing||Loan:
There is a maximum mortgage limit that may vary by state and county
Must meet certain standards, as determined by an FHA-approved appraiser. Read our article about FHA approved homes.
Must be the buyer’s primary residence
|Purchase limit||For an FHA loan, the property being financed cannot exceed certain amounts, depending on the area. HUD.gov has an online loan limit calculator buyers can check before getting started.|
|Typical length of loan||15- or 30-year mortgages although most people opt for the 30 year amortized version.|
Taking the Next Step
Although most lenders offer FHA loans, not all lenders are the same. They all do not offer every feature of what the FHA guidelines permit. Read our article on the best FHA lenders and then we can connect you with an FHA lender in your area.
Also, check out the FHA’s handbook for home loan shopping, “Looking for the Best Mortgage.” In it, you will learn how important it is to shop around, compare, and negotiate to get the loan that serves you best.
What is a Conventional Mortgage?
To begin with, a conventional mortgage does not have the flexibility an FHA does in terms of the ability to work with lower credit scores and down payments. But if you qualify for a conventional loan, you may be able to avoid private mortgage insurance (PMI) which would be a huge monthly savings.
A conventional loan conforms to established guidelines for the size of the loan and your financial situation.
Fixed Rate Mortgage vs. Adjustable Rate Mortgage
The monthly mortgage amount, including principal and interest, on a conventional fixed-rate mortgage is consistent throughout the life of the loan. The interest rate won’t change for the life of your loan. Your payment never goes up or down. This loan is well-suited to borrowers who plan to stay in their homes for a long period of time.
30-year fixed mortgage: This popular loan has lower monthly payments, with its fixed interest rate and long-term repayment schedule. Interest adds up higher in comparison to a shorter-term mortgage.
Less than 30-year mortgage: The shorter the term you take to pay back your loan, the faster you will pay off the loan and the more you’ll save on interest. However, the shorter-term loan will have a higher payback.
|Adjustable-rate Mortgage (ARM)
With an ARM, also called a variable-rate mortgage, the monthly mortgage payment, including principal and interest, is lower during the first few years. The first years of an ARM will be “locked-in” for as long as it is negotiated.
Common terms for the locked-in interest rate are 3, 5, 7, and 10 years. You will see them listed as 3/1, 5/1, 7/1 and 10/1 ARMs. The first number represents how long the rate is frozen and the 1 represents how many times each year the interest rate may change.
The potential interest rate change is due to the federal funds rate. Based on that rate, lenders tend to increase the interest rates on mortgages, because their expenses increase.
Ideal for: Borrowers who plan to move within the first several years, before interest rate increases.
Requirements of a Conventional Loan
While conventional loans may be slightly less complicated than FHA loans in terms of processing and inspections, but they have their own set of requirements and rules for eligibility and repayment.
A minimum down payment of 5 percent is required by a conventional loan – and any higher you can go is better. The recommendation is 20 percent.
Borrowers typically need strong credit scores to qualify for a conventional loan. Your debt-to-income ratio also matters. While the actual numbers vary from lender to lender, in general, everything about your credit needs to be a little bit stronger to qualify for a conventional loan.
Some conventional mortgages are conforming loans, meaning they conform to guidelines that allow them to be purchased by Fannie Mae and Freddie Mac. Loans that adhere to these guidelines are eligible to be invested in and backed by these two companies. Conforming loans are standardized along these guidelines and currently have a financing limit of $484,350 as of November 2018.
Non-conforming conventional loans
These are the least standardized of all loans. Eligibility requirements vary, as do pricing and features of the loans. Consumerfinance.gov is a government website that has consumer-oriented information on how these loans work.
Interest rates available to borrowers with a conventional loan may be slightly higher than with an FHA loan but, again, this is due to the reduced risk associated with being an FHA insured loan.
Summary FHA vs Conventional Loan
The difference between an FHA vs conventional loan is fairly significant and every home buyer must make his or her own educated decision on which option is best for you. You may want to qualify for one of these program but will find that your credit score, or your down payment is not optimal. This is why your first step should be to discuss your personal scenario with a lender far in advance.
Having a discussion with a lender early will allow you some time to repair your credit or to make other preparations to help you to either qualify or to get a better interest rate. We suggest speaking to one of our national FHA lenders who can answer your questions about FHA vs conventional loans and provide rate quotes regardless as to which program you are interested in.
Which rates are better between FHA vs conventional?
If you have average to very good credit, you may find that FHA rates will be better than conventional mortgage rates. However, when you factor in the cost of the FHA mortgage insurance, your monthly payment may be similar or even higher with an FHA loan.
Which is more popular between an FHA and conventional loan?
There are more conventional loans taken out by borrowers every year, but FHA loans are at least 25% of all mortgages today.
A home is the largest purchase most people will make in their lifetime. Doing research, seeking counseling, and even taking a prep course are all steps worth taking before applying for a mortgage.
What you need to know about getting a mortgage – This is an excellent resource to review prior to making a final decision about your mortgage.
Housing Resources Inc., – A nonprofit organization offering home buyer education