If you’re looking to finance your first home with a mortgage, the decision between an FHA loan (or any government-backed loan) or a conventional loan can be quite tricky.
But don’t worry just yet. Your answer is here. We’ll crack that safe open for you in this article by taking a deep dive into the differences between conventional loans and FHA loans, exploring their credit score down payment, and income requirements.
So, grab your hard hat, and let’s dive in!
What is an FHA Loan?
FHA loans are a type of mortgage backed by the Federal Housing Administration that allows you to buy a home with a lower down payment and lower credit score than a conventional loan.
This makes it easier for first-time homebuyers or those with lower incomes to purchase a home. They have more flexible requirements for income, debt-to-income ratio, and employment history.
FHA loans are a great option for anyone looking to become a homeowner.
What is a Conventional Loan?
Unlike the FHA loan, a conventional loan is not backed by the government and is often referred to as a “traditional” or “conforming” loan.
This means the lender takes on more risk when lending you money to buy a home, so you may need to meet stricter requirements, such as having a higher credit score, a larger down payment, and a lower debt-to-income ratio.
The upside? Most conventional loans often come with lower interest rates and fees compared to government-backed loans, such as FHA loans.
If you have a strong financial standing and want more flexibility in your loan terms, a conventional loan can be a good option.
FHA Loan vs Conventional Loan Calculator
When it comes to purchasing a home, it’s important to consider all of your loan options.
But which one is better? This depends on your individual circumstances and financial goals. Use a FHA loan vs conventional loan calculator to compare your options and determine which loan type is the best fit for you.
Here’s a closer look at the differences in criteria for the FHA and Conventional loan programs.
| Criteria | FHA Loan | Conventional Loan |
|---|---|---|
| Minimum down payment | 3.5% | 5% |
| Credit score | 580 or higher | 640 or higher |
| Mortgage Insurance | Required | Required if <20% down |
| Loan limits | Lower | Higher |
| Property standards | Stricter | More lenient |
FHA Loans vs Conventional Loans: Which is Better?
Deciding between an FHA loan and a conventional loan largely depends on your current financial situation and ability to meet each option’s eligibility requirements.
To give you a fair overview of the two, we compare their key differentiation areas.
FHA vs Conventional Loan: Requirements
The eligibility criteria outline the various requirements that you must meet to qualify for either loan option.
The differences between FHA and conventional loan requirements include:
- Credit score: FHA loans are known for their more lenient credit score requirements, allowing borrowers with credit scores as low as 580 to qualify for a loan. Even borrowers with credit scores between 500-579 may still be eligible for an FHA loan, but they will need to make a larger down payment. Conventional loans have a greater credit rating than FHA loans, with most banks requiring a rating of at least 640 to begin with.
- DTI (debt-to-income) ratio: The DTI ratio is the percentage of your gross monthly income that goes toward paying off debt. FHA loans typically allow a higher DTI ratio than conventional loans, with a maximum of 43% for most borrowers.
- Mortgage Insurance: Conventional loans require private mortgage insurance (PMI) if your down payment is less than 20% or the loan-to-value (LTV) ratio is above 80%. PMI is paid as a monthly premium or a one-time upfront premium. On the other hand, FHA loans require mortgage insurance premiums (MIP) regardless of the down payment amount or LTV ratio. You will pay an upfront MIP premium at the time of closing and an ongoing monthly MIP premium for the life of the loan.
FHA vs Conventional Loan: Down Payment
FHA and conventional loans require a down payment, but the amount required can vary significantly. FHA loans, for instance, are known for their low down payment requirements.
Currently, the minimum down payment required for an FHA loan is 3.5% of the home’s purchase price. This means that if you’re buying a $200,000 home, you’ll need to come up with $7,000 for the down payment.
Conventional loans, on the other hand, generally require a larger down payment. The exact amount can vary depending on the lender, your financial situation, and the loan amount you qualify for, but it’s not uncommon for lenders to require a down payment of 10% or more.
FHA vs Conventional Loan: Mortgage Insurance
Both FHA and conventional loans require some form of mortgage insurance, but they have significant differences. FHA loans require mortgage insurance premiums (MIP) for the entire loan term, regardless of the loan-to-value (LTV) ratio.
The upfront MIP is typically 1.75% of the loan amount, and the annual premium ranges from 0.45% to 1.05% of the outstanding loan balance, depending on the LTV ratio and loan term. The MIP on FHA loans can only be canceled if the borrower puts down at least 10% and has paid MIP for at least 11 years.
Conventional loans may require private mortgage insurance (PMI) if you put less than a 20% down payment on the purchase price. These rates vary based on the borrower’s credit score and the loan-to-value ratio. The PMI on conventional loans can be canceled when the borrower reaches 20% equity in their home.
FHA vs Conventional Loan: Interest Rates
Because of the added government backing, FHA loans typically have slightly lower interest rates than conventional loans. These low-interest rates result in lower monthly payments that can potentially save you money over the life of the loan.
As already established, conventional loans are not government-backed and are typically offered by banks or private lenders. As a result, they usually have slightly higher interest rates than FHA loans. And unlike the FHA loan, these rates may result in higher monthly payments, which can impact the affordability of the loan.
However, if you look at both carefully, you’d notice that the interest rates of FHA and conventional loans are comparable, even with FHA loans having slightly lower rates. The added cost of mortgage insurance premiums for FHA loans puts the two loan options at a similar rate.
FHA vs Conventional Loan: Refinancing
FHA loans have refinancing options such as the FHA Streamline Refinance, a simplified process that allows you, a homeowner, with an existing FHA loan to refinance your home to a lower interest rate without needing an appraisal or income verification.
Similarly, conventional loans also have refinancing options such as the Rate-and-Term Refinance, similar to the FHA Streamline Refinance, as it allows homeowners to refinance at a lower interest rate. Still, it may require an appraisal and income verification.
Pros and Cons of FHA Loan vs Conventional Loan
Deciding between conventional and FHA loans also means evaluating their pros and cons and choosing which best suits your current financial situation. The tables below can help you make a decision.
Comparing the Pros
Here are the best parts of using either loan option to finance your dream home.
| Pros | FHA Loans | Conventional Loans |
|---|---|---|
| Assumable | Loans are assumable, which can be advantageous when selling a home | Loans are typically not assumable |
| Closing Costs | Allows for some of the closing costs to be rolled into the loan, which can help reduce the cash needed at closing | You’re responsible for all closing costs, which can add up to a significant amount |
| Credit Requirements | More lenient credit score requirements allow borrowers with lower credit ratings (as low as 500) to qualify for a loan | Higher credit score requirements, typically 640 or above, may make it harder for some borrowers to qualify |
| Down Payment | Allows for lower down payment requirements, as low as 3.5% of the purchase price | Down payments may range from 5% to 20% of the purchase price |
Comparing the Cons
Here are the reasons why either loan option may not be the ideal option for your current financial situation.
| Cons | FHA Loans | Conventional Loans |
|---|---|---|
| Appraisal Requirements | FHA loans require a more rigorous appraisal process, which may make it harder to get approval for certain properties | Appraisal requirements may be less strict, but the lender may still require certain repairs |
| Interest Rates | FHA loans may have higher interest rates compared to conventional loans | Interest rates may be lower for borrowers with higher credit scores |
| Loan Limits | FHA loans have limits, which may be lower than what a borrower needs | No loan limits, but the lender may have their limits |
Why Choose FHA Loan Over Conventional Loan?
If you’re considering an FHA loan over a conventional loan after the breakdown above, here are some other reasons why that may be the best option:
- Lenient credit score requirements: FHA loans allow borrowers with lower credit ratings to qualify for a loan. Conventional loans require a credit rating of 640 or above.
- Lower down payment requirements: FHA loans permit lower down payments, as low as 3.5% of the purchase price, compared to conventional loans, which may require down payments ranging from 5% to 20% of the purchase price.
- Rolling closing costs into the loan: FHA loans allow some closing costs to be moved into the loan, which can help reduce the cash needed at closing.
- Assumable: If you decide to sell your home, the buyer can take over your FHA loan at the same interest rate, which can be beneficial if interest rates have risen since you purchased your home.
- Have lower closing costs: FHA loans often have lower closing costs than conventional loans. Why? because the FHA limits the fees that lenders can charge, saving you money.
If you’re looking to find a reputable vendor for your FHA loan, we can be of help.
We’ve guided many to their first home purchase and can help you navigate the journey with a tailored experience to your financial situation. Give us a call if you intend to fund a home in any of our service areas.
Can I Have an FHA Loan and a Conventional Loan?
Having an FHA and a conventional loan is rare but possible.
You can take out a conventional loan to cover a portion of the home’s purchase price and then use an FHA loan for the remainder. You can also have both types of loans for different properties you own.
But, it’s important to note that having two mortgages can impact your debt-to-income ratio, which is a key factor in the loan approval process.
Other Comparisons
Conventional 97 Loan vs FHA Loan
The Conventional 97 loan is ideal if you’re a first-time homebuyer or have limited funds for a down payment. It allows you to purchase a home with as little as a 3% down payment compared to the typical 5% on standard conventional loans.
Offered by Fannie Mae, this conventional mortgage program has specific eligibility requirements and guidelines to qualify and is a viable alternative to FHA loans if you meet the criteria and prefer a conventional loan.
Between the two, here are some of the differences:
- Credit score requirements: The 3% conventional loan may require stricter credit score requirements than the FHA loan, making it more difficult for borrowers with lower credit ratings to qualify.
- Down payment: The conventional 97 loan requires a down payment of only 3%, while the FHA loan requires a down payment of 3.5%.
- Mortgage insurance: The conventional 97 loan does not require mortgage insurance if you meet specific credit score requirements. In contrast, the FHA loan requires upfront and ongoing mortgage insurance premiums.
FHA Loan vs First Time Home Buyer Programs
First-Time Home Buyer Programs are designed to help you buy your first home. They are typically offered by state, local, or federal governments, as well as nonprofit organizations, and provide benefits such as down payment assistance, lower interest rates, or reduced closing costs.
These programs aim to make homeownership more accessible and affordable, especially for those with limited savings or credit history. Be sure to research and explore available options in your area to see if you qualify for any of these programs.
Both the FHA loan and first-time buyer programs can help you achieve your goal of owning a home, but they have some crucial differences. Let’s evaluate.
- Down payment: While FHA loans require a minimum of 3.5% down, many first-time home buyer programs offer much lower down payment options, as low as 0%.
- Facilitation: FHA loans are funded by private lenders and insured by the government, while state or local governments often fund first-time buyer programs.
- Property type: FHA loans can be used to purchase a variety of property types, including single-family homes, condos, and manufactured homes, while first-time buyer programs may have restrictions on the type of property that can be purchased.
Frequently Asked Questions
Are there restrictions on the type of property that can be purchased?
Conventional Loans can be used to purchase single-family homes, duplexes, triplexes, and quadplexes. FHA Loans can be used to purchase single-family homes, as well as multi-unit properties (up to four units) and manufactured homes. You can also use them for refinancing and home renovations through the FHA 203k loan.
What are the potential pitfalls of conventional and FHA Loans?
Conventional Loans
- High monthly payments: Since conventional loans often require larger down payments, you may find yourself with higher monthly payments than you can afford.
- Private mortgage insurance: If you put down less than 20% of the home’s purchase price, you may have to pay for PMI.
- Strict lending requirements: You must have good credit scores, a stable income, and a substantial down payment to qualify for a conventional loan.
FHA Loans
- Limits on loan amounts: FHA loans have maximum loan limits, meaning you may not be able to purchase higher-priced homes in more expensive areas.
- Mortgage insurance premiums: You must pay an upfront MIP (mortgage insurance premium) (MIP) as well as annual MIPs. This can add to the cost of the loan over time.
- Property requirements: FHA loans require that the property meets certain minimum property standards to qualify for financing.
Why do sellers prefer conventional over FHA?
The main reason sellers prefer conventional loans over FHA loans is the stricter appraisal and inspection requirements for FHA loans.
FHA loans require the home to meet specific minimum property standards. Any issues discovered during the appraisal and inspection process must be repaired (by the seller) before the loan can be approved.
Which is the Best Option for You?
Conventional and FHA loans have unique pros and cons.
At the base, however, conventional loans are better if you have a higher credit score and a larger down payment, while FHA loans are better if you have a lower credit score and a smaller down payment.
If you’re still unsure which home-buying loan best suits your needs, feel free to get in touch with us, and we’ll provide you with much-needed advice.
We can also help you pick a loan option tailored to your unique financial situation. So don’t hesitate to pick up your phone. We’d be happy to hear from you.
