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If you’re shopping for a home, getting a mortgage loan can be the largest hurdle standing between you and your dreams. With so many types of mortgages available, it’s easy to feel lost when trying to decide what loan is best for you.
One big question for borrowers (especially first-time buyers) is whether a Federal Housing Administration (FHA) or conventional mortgage loan makes more sense. Each has its array of advantages and challenges.
What Are the Differences Between FHA vs. Conventional Loans?
Regular lenders like banks, credit unions and online lenders offer both conventional loans and FHA loans, and both types of mortgages offer fixed-rate or adjustable-rate mortgages (ARM). To understand the differences, it’s helpful to ask some key questions.
Who backs the loans?
Conventional loans: Sometimes referred to as conforming loans or conventional home loans, these loans represent the majority of U.S. mortgages and are offered through banks, credit unions and other lenders. Even though the government doesn’t have a say in these loans, they usually need to conform to standards set by Fannie Mae and Freddie Mac.
FHA loans: Also offered through regular lenders, but backed by the federal government through the U.S. Department of Housing and Urban Development. Because they’re backed by the government, lenders know they are at least partially covered if you default on the loan.
That means lenders are willing to extend FHA loans to borrowers who may have a harder time getting approved for a conventional loan.
Who tends to use them?
Whether you apply for a conventional loan or an FHA loan, lenders are legally required to consider your application and can’t turn down your loan without a good reason. That said, conventional and FHA loans tend to be better suited to different types of borrowers.
Conventional loans: Most home buyers with credit scores above 620 and good credit can qualify for a conventional loan.
FHA loans: While anyone can apply for an FHA loan, they tend to be a better option for first-time home buyers, home buyers with credit scores between 500 and 619 and home buyers with past bankruptcies or other credit issues.
What can they be used for?
Conventional home loans and FHA home loans have different limits on the types of properties you can buy with them.
Conventional loans: Can be used to purchase any type of home, including a primary residence, a vacation home or a rental or investment property.
FHA loans: Reserved primarily for buyers looking to buy a primary residence. There are some exceptions. You can use an FHA loan to buy a multi-family home (up to 4 units) as long as one of the units is your primary residence.
Is mortgage insurance required?
Mortgage insurance is an additional monthly fee you pay on top of your principal and interest to help insure the lender if you default on the loan.
For conventional loans: Referred to as mortgage protection insurance or private mortgage insurance (PMI). Lenders usually waive it if you pay 20% or more down or remove it once you’ve reached 78% – 80% equity in your home. This usually adds between $30 – $70 to your mortgage payment for every $100,000 borrowed.
For FHA loans: Referred to as mortgage insurance premium (MIP), MIP usually includes an upfront mortgage insurance premium (UFMIP) of 1.75% or $1,750 per $100,000 borrowed that can be added to your closing costs.
After that, you’ll be responsible for an annual payment (you can pay it in monthly installments) ranging from 0.45% – 1.05% of your loan amount or $450 – $1,050 per $100,000 borrowed. These payments can last between 11 years to the lifespan of your loan.
What shape does the home need to be in?
When you take out a loan, your lender has a vested interest in the condition of the property you plan to buy. How lenders determine the condition and the requirements that go with it can differ depending on the type of loan.
Conventional loans: Lenders will usually require a property appraisal before they approve a loan. Along with comparable home values, the appraiser will take the overall condition of the home into account when determining the price. If the appraised value is less than the purchase price of the property, the lender can choose to not approve the loan.
FHA loans: The government requires that homes meet some standards before anyone can buy one with an FHA loan. These requirements are there to protect the borrower, including making sure that the roof, electrical wiring and HVAC system are all up to code.
Are there loan limits?
Both conventional and FHA loans have limits on the amount you can borrow. The government sets these limits and usually bases them on the property values where you live.
Conventional loans: Conventional loan limits for a single-family home range from $726,200 to $1,089,300. You may be able to borrow more if you’re buying a multi-family property or a rental property, or you may need to apply for a non-conforming or jumbo loan.
FHA loans: The limits for FHA loans for a single-family home range from $472,030 to $1,089,300. You could borrow more if you plan to buy a multifamily home with up to 4 units, as long as you plan to live in one of the units. There are FHA multifamily loans available, but they come with additional income and down payment requirements.
Which has a better mortgage interest rate?
Conventional loans tend to have lower interest rates compared to FHA loans because they are seen as higher risk. However, if your credit score is low and you can’t qualify for a conventional loan, you may be able to get a better interest rate with an FHA loan. This scenario might happen if a lender offered a conventional loan with significantly higher interest rates to offset the risk of a lower credit score.
Interest rates depend on the type of loan you’re offered, so pay attention to whether the mortgage is a fixed-rate or adjustable-rate mortgage (ARM). Fixed-rate loans may seem a little more expensive now, but the interest rate is locked in for the entirety of your loan. An ARM is a bit riskier because when the Federal Reserve changes rates, your monthly payment could also change.
Also note, conventional mortgages can offer loan terms ranging from 10- to 40-year mortgages. FHA loans tend to have either 15-year or 30-year terms.
Can I refinance my mortgage?
You can refinance both conventional and FHA mortgage loans, allowing you to qualify for a lower interest rate, or to lower or completely dump your mortgage insurance.
If you have an FHA loan, you have the option to refinance to a conventional mortgage or take advantage of an FHA Streamline refinance loan.
Both conventional and FHA loans offer the option of a cash-out refinance, where you borrow more money than you owe and pocket the difference. The key to qualifying is having enough home equity, which is the difference between the appraised value of your home and the amount you currently owe.
Also, while the FHA does not offer them, you can get a home equity loan or home equity line of credit (HELOC) through a bank, credit union or other lenders if you have an FHA loan.
What Are The Requirements of an FHA vs. Conventional Loan?
There’s a lot more that goes into any loan than what we’ve already covered. FHA loans and conventional mortgages have additional requirements that may make them more attractive to different types of buyers. Here are some of the differences in requirements between FHA and conventional loans.
Credit score requirements
Your credit score is a number ranging from 300 – 850 that represents your creditworthiness. It’s also one of the first things a lender will consider when looking at your mortgage application.
Conventional loans: To qualify for a conventional loan, lenders usually require a minimum credit score of 620 or higher. A higher credit score makes you more likely to qualify for a lower interest rate.
FHA loans: Because the government insures FHA loans, lenders are willing to approve your loan if you have a credit score as low as 500.
Debt-to-income (DTI) ratio
Your debt-to-income ratio measures your fixed monthly payments (rent or mortgage payment, credit card minimums, auto, personal and student loan payments) against your gross monthly income.
Conventional loans: Lenders prefer a DTI of 45% or less, but you can qualify for a loan with a DTI up to 50%.
FHA loans: Lenders require a DTI of 43% or less to qualify.
Interest adds up, especially over 20 or 30 years. That’s why your down payment matters. Putting more money down lowers the amount of money you’re paying interest on over time and also affects how much you’ll need to pay in mortgage insurance.
Conventional loans: While 20% is preferred (especially if you want to avoid PMI), there are loan programs that allow home buyers to qualify with as little as 3% down if they’re buying a primary residence.
FHA loans: You can qualify for a 3.5% minimum down payment with a credit score of 580 or higher. If your credit score is between 500 – 579 you’ll need to put 10% down.
FHA loans and some conventional loans also allow you to take advantage of different down payment assistance programs that can offer grants or low-interest loans to help cover your down payment, closing costs and other home buying expenses.
When Does a Conventional Loan Make Sense?
If you have good to excellent credit, a conventional loan might make more sense. You may qualify for a better interest rate, gain the ability to opt out of PMI, and are a more attractive buyer in a seller’s eyes. Conventional loans don’t have the same home inspection standards, so sellers are less likely to need to do repairs that address safety issues.
When Does an FHA Loan Make Sense?
The government created FHA loans to help people with low-to-middle incomes afford a home by reducing the requirements they need to satisfy to gain approval.
So if you’re looking for a home and don’t have a lot of money to put down, are shopping in a more expensive housing market or have blemishes on your credit report, an FHA loan may make more sense for you.
It’s Not the Loan That’s Right – It’s What’s Right for You
FHA loans are a popular choice because they have less restrictive qualifications for factors like credit scores, income and the size of the down payment. Before you decide what type of loan is right for you, do your homework and be extra vigilant about your financial choices. Your home is likely the most expensive item you’ll purchase, so find the loan that’s right for you.
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The Short Version
- Lenders are willing to extend FHA loans to borrowers who may have a harder time getting approved for a conventional loan
- Conventional home loans and FHA home loans have different limits on the types of properties you can buy with them
- Both types of loans have benefits – FHA loans give people with lower incomes the chance to qualify for a loan while conventional loans help people with good credit scores get better interest rates
Fannie Mae. “B3-5.1-01, General Requirements for Credit Scores (09/01/2021).” Retrieved February 2022 from https://selling-guide.fanniemae.com/Selling-Guide/Origination-thru-Closing/Subpart-B3-Underwriting-Borrowers/Chapter-B3-5-Credit-Assessment/Section-B3-5-1-Credit-Scores/1032996841/B3-5-1-01-General-Requirements-for-Credit-Scores-08-05-2020.htm
Federal Depositors Insurance Corporation. “203(b) Mortgage Insurance Program.” Retrieved February 2022 from https://www.fdic.gov/resources/bankers/affordable-mortgage-lending-center/guide/part-1-docs/203b-mortgage-insurance-program.pdf
Freddie Mac. “Pricing Out PMI – My Home.” Retrieved February 2022 from https://myhome.freddiemac.com/blog/homeownership/20190913-private-mortgage-insurance
U.S. Department of Housing and Urban Development. “APPENDIX 1.0 – MORTGAGE INSURANCE PREMIUMS.” Retrieved February 2022 from https://www.hud.gov/sites/documents/15-01MLATCH.PDF
Federal Housing Finance Agency. “FHFA Announces Conforming Loan Limits for 2023.” Retrieved January 2023 from https://www.fhfa.gov/Media/PublicAffairs/Pages/FHFA-Announces-Conforming-Loan-Limits-for-2023.aspx
U.S. Department of Housing and Urban Development. “FHA Mortgage Limits.” Retrieved January 2023 from https://www.hud.gov/program_offices/housing/sfh/lender/origination/mortgage_limits
Fannie Mae. “B3-6-02, Debt-to-Income Ratios (02/05/2020).” Retrieved February 2022 from https://selling-guide.fanniemae.com/Selling-Guide/Origination-thru-Closing/Subpart-B3-Underwriting-Borrowers/Chapter-B3-6-Liability-Assessment/1032992131/B3-6-02-Debt-to-Income-Ratios-02-05-2020.htm#DTI.20Ratios
Federal Deposit Insurance Corporation. “203(b) Mortgage Insurance Program.” Retrieved February 2022 from https://www.fdic.gov/consumers/community/mortgagelending/guide/part-1-docs/203b-mortgage-insurance-program.pdf
Fannie Mae. “HomeReady Mortgage.” Retrieved February 2022 from https://singlefamily.fanniemae.com/originating-underwriting/mortgage-products/homeready-mortgage
U.S. Department of Housing and Urban Development. “FHA Mortgage Limits.” Retrieved February 2022 from https://www.hud.gov/program_offices/housing/sfh/lender/origination/mortgage_limits