Conventional vs. FHA
When you are in the market for a new home, one of the most important decisions you will make is which type of loan to choose. There are a variety of loans available, each with its own benefits and drawbacks.
One popular option is the FHA loan, but what’s the difference between a conventional loan and a FHA loan?
In this article, we will explore the key differences between these two types of loans and help you decide which is right for you.
- Conventional Loans
- FHA Loans
- What is mortgage insurance and do I pay it with a Conventional loan?
- What is a funding fee and is it required on a Conventional loan?
- Conventional doesn’t allow for blemishes on credit
- Debt to income ratio on a Conventional is stricter than FHA.
- Interest rates on a Conventional are typically higher than FHA
- Conventional loans don’t require repairs
- Refinancing is easier with an FHA loan
- Conventional doesn’t require condo approval like FHA.
- Conventional vs FHA – Summary
A conventional loan is a traditional mortgage that is not backed by the government. The requirements to qualify for a conventional is stricter than the FHA loan.
Conventional loans are available in both fixed-rate and adjustable-rate varieties, and conventional loan interest rates are typically higher than FHA loans. Additionally, there are a variety of loan terms available, ranging from ten to thirty years.
Conventional loans are a good choice for borrowers with strong credit scores and stable incomes.
If you have less-than-stellar credit, a conventional loan may not be an option for you.
Conventional has a first time home buyer program with down payment as low as 3%.
If you are already own a home and are purchasing again, there are down payment options as low as 5%, and so on.
An FHA loan is a mortgage that is backed by the federal government and can only be used on a primary residence. The purpose of this program is to help borrowers obtain mortgages at affordable interest rates and terms with little or no money down.
FHA loans have lower credit score requirements than conventional loans, as well as more flexible debt-to-income ratios.
FHA loans are a good option for borrowers with low credit scores, credit blemishes or who cannot afford a large down payment.
The credit requirements for an FHA loan are far less strict than a Conventional loan.
They offer competitive interest rates and flexible terms, making them ideal for first-time homebuyers. However, FHA loans come with additional fees that conventional loans do not have, so they may be more expensive in the long run.
More FHA loan info:
What is mortgage insurance and do I pay it with a Conventional loan?
Mortgage insurance also known as PMI, is a type of coverage that protects the lender in case you default on your loan. If you aren’t able to make payments, the mortgage insurance company will pay off some of what’s owed so they can recoup their losses from lending money to borrowers who are unable to pay back debts.
Mortgage insurance premiums vary based on factors such as how much money is being borrowed, the credit rating of borrower, loan to value, and debt ratio.
When a down payment of less than 20% is being made, you must pay monthly mortgage insurance.
Conventional Mortgage Insurance (PMI):
Required when making a down payment that is less than 20%. Can be removed once you hit 80% loan to value ratio on your home.
You can remove the mortgage insurance by refinancing, or simply by calling your lender and asking them to remove the PMI from the loan.
FHA Loan Mortgage Insurance (PMI):
With an FHA loan the PMI is always required, even if you make a larger down payment. The PMI stays on the loan for life. The only way to remove the PMI would be to refinance out of an FHA loan into a conventional loan.
What is a funding fee and is it required on a Conventional loan?
A funding fee also known as a upfront mortgage insurance on an FHA loan is required. It is 1.75% of the loan amount and is rolled into the loan. Buyers can pay this fee out of pocket but most borrowers roll it in.
The funding fee is what keeps the FHA program going. It is a risky loan for lenders due to having such a low down payment and lenient guidelines, so the funding fee helps HUD and lenders with any losses in case a borrower defaults.
Conventional does not have a funding fee.
Conventional doesn’t allow for blemishes on credit
A conventional loan typically requires a credit score of 640 or higher. On a case by case basis, scores between 620-639 can qualify depending on the amount of assets the borrower has.
FHA Loan Credit Score:
Minimum credit score needed for FHA is a 620. Again, on a case by case basis scores between 580-619 may be able to qualify depending on the amount of assets, and debt ratio the borrower has.
Debt to income ratio on a Conventional is stricter than FHA.
The maximum debt-to-income ratio for a Conventional Loan is 45%. This means your monthly debts (including the mortgage payment) cannot exceed 45% of your gross income. We have gone up to a 50% debt ratio, but the borrowers had very high scores and a good amount of assets.
FHA Loan Debt to Income Ratio:
FHA is lenient compared to Conventional. The maximum debt-to-income ratio for an FHA loan is 50%. We’ve had borrower go as high as 55%. High debt-to-income ratios do require compensating factors, which would be credit score, or a good amount of assets.
Interest rates on a Conventional are typically higher than FHA
The interest rates on a Conventional Loan are usually higher than the interest rates on an FHA loan, BUT the conventional loan doesn’t require homeowners insurance or property taxes to be included in the monthly mortgage payment.
Also the mortgage insurance may be lower on a Conventional loan than it is on FHA.
Even though the rate is higher, you don’t have to pay the funding fee of 1.75% and the monthly PMI may be lower than FHA. Ask your loan officer to break down the different options for you.
The rate is not always higher, if you have really great credit, it may be lower than the FHA interest rate.
FHA Loan Interest Rates:
FHA is a governent program and typically has lower interest rates than Conventional. FHA does require the property taxes and the homeowners insurance to be included in the monthly payment. The PMI may also be higher on FHA than Conventional.
Conventional loans don’t require repairs
In a sellers market, when there are multiple offers on a house, the seller will most likely choose a buyer who is getting a conventional loan rather than FHA.
FHA requires properties to meet their standards of safety. An appraiser will make sure the home you buy fulfills these requirements.
If the home isn’t up to FHA standards, repairs will be required to close the loan.
Conventional loans don’t have safety requirements that need to be met.
It is less work and money for the seller to go with a buyer who is using a conventional loan rather than FHA, since they don’t have to worry about repair requirements.
If the property is in great condition, then the seller may go with an FHA buyer. It really depends on the property and offers that the seller is getting.
Refinancing is easier with an FHA loan
If you currently have an FHA loan, and want to refinance to take advantage of a lower rate – it’s easier to refinance with FHA.
FHA has a loan called the “FHA streamline”, the loan doesn’t require an appraisal or income documents. It’s quick and easy.
Conventional will require an appraisal and income documents. Borrowers will need to make sure that they meet the debt-ratio guidelines and the appraisal would need to come in at value.
It will take more time to complete a conventional refinance than an FHA refi.
Conventional doesn’t require condo approval like FHA.
If purchasing a condo, it has to be FHA approved if using an FHA loan. Conventional does not have this requirement.
You can checkout which condos are approved by going here.
Conventional vs FHA – Summary
- Have higher credit standards. Doesn’t allow credit blemishes.
- Debt to income ratios are stricter
- PMI can be removed at 80% loan to value
- Refinances require income docs and appraisals
- Allowed to purchase investment properties
- Has down payments as low as 3%
- Can purchase condos
- Allowed to waive property tax and homeowners insurance from monthly payment
- Closing costs are less
- Sellers prefer conventional buyers
Conventional typically cost less than FHA loans but can be harder to get
- Lower credit standards
- Minimum down payment is 3.5%
- PMI is always required, and cannot be removed
- Funding fee of 1.75% required
- Interest rates are lower
- Easier to refinance in the future
- FHA has property standards that need to be met that could require repairs before a loan can close
- Condos have to be FHA approved
- Only for primary residence
FHA loan is a government loan and tends to have loan requirements that are easier to meet, making homeownership a possibility for more people.
Which loan is right for you? That depends on your individual circumstances. If you have a strong credit score and stable income, a conventional loan may be the best option. However, if you have a low credit score or cannot afford a large down payment, an FHA loan may be better suited for you.