While both allow consumers to finance the purchase of a home, there are several key differences between FHA loans and conventional loans.
FHA Loans vs. Conventional Loans: An Overview
Home buyers qualify for various types of mortgages based on their financial profiles. Common mortgages tend to be conventional loans. But there are others that are backed and insured by the Federal Housing Administration (FHA). While both allow consumers to finance the purchase of a home, there are several key differences between FHA loans and conventional loans.
FHA loans make homeownership possible and easier for low- to middle-income borrowers who may not otherwise be able to get financing because of a lack of or a poor credit history, or because they have limited savings. Those who qualify for an FHA loan are eligible for a lower down payment. The credit requirements aren’t as strict as other mortgage loans. Someone with a credit score below 580 may get approved for financing. These loans are not granted by the Federal Housing Administration itself. Instead, they are advanced by FHA-approved lenders.
On the other hand, consumers with established credit and low levels of debt, usually qualify for conventional mortgages. These loans are generally offered by private mortgage lenders like banks, credit unions, and other private companies. Unlike FHA loans, conventional mortgages aren’t backed or secured by the government.
About FHA Loans
FHA loans are federally insured and issued by FHA-approved lenders, including banks, credit unions, and other lending companies. FHA loans are intended for home buyers with lower credit scores and limited savings. FHA loans can be used to buy or refinance single-family houses, multi-family homes with up to four units, condominiums, and certain manufactured and mobile homes. There are also specific categories of FHA loans that can be used for new construction or to finance the renovation of an existing home. FHA loans are federally insured. This means that lenders are protected if a borrower defaults on their mortgage. Lenders can offer more favorable terms, including lower interest rates, to consumers who might not otherwise qualify for a home loan. Essentially, it’s easier to qualify for an FHA loan than for a conventional loan.
The qualifying standards of FHA loans make home buying more accessible for a greater number of people. As of 2021, you can borrow up to 96.5% of the value of a home with an FHA loan. FHA mortgage applicants with credit scores as low as 580 may be approved for a home loan—provided that they have enough to cover the 3.5% down payment requirement. Those whose credit scores fall below 580 may still qualify but generally need to put down a minimum of 10% of the purchase price. Many lenders require FHA mortgage applicants to have credit scores between 620 and 640 for approval. Mortgage insurance is a mandatory condition for FHA loans.
About Conventional Loans
Conventional loans are originated and serviced by private mortgage lenders, such as banks, credit unions, and other financial institutions. Conventional loans present the most risk for lenders because they are not insured by a government agency and have stricter lending requirements. For this reason, lenders extend conventional mortgages to applicants who have the strongest financial profiles. Conventional down payment requirements range from 3% to 40%, depending on the mortgage product. Mortgage insurance is required if down payment is less than 20%.
To qualify for a conventional loan, a home buyer must have a good credit history report and a credit score of at least 680. Conventional loan interest rates vary depending on three variables: the amount of the down payment, the consumer’s choice of mortgage product, and current market conditions. Most conventional loans come with fixed interest rates, which means that the rate never changes throughout the life of the loan. Borrowers are able to refinance their home if rates change.
Lets review a few key differences between FHA Loan vs. Conventional Loan:
Pros and Cons of Conventional Loans
Conventional loans are not limited to purchasing a primary residence. Eligible borrowers can use the loan to buy a rental property or vacation home. Lenders of conventional mortgages typically only require borrowers to purchase mortgage insurance when they have a 20% down payment. Once a borrower pays down enough of the mortgage’s principal, insurance can be canceled. Because conventional mortgages are not guaranteed by the government, they typically have stricter lending requirements, including a higher credit score and a lower debt-to-income (DTI) ratio.
FHA Loans vs. Conventional Loans: The bottom line
Choosing between an FHA loan or a conventional loan comes down to your unique financial situation. If you have credit challenges, need to use gift funds for your down payment or have a higher debt-to-income ratio, an FHA loan may be your best option. If you have a fairly solid financial profile, you may be better off with a conventional loan.
For today’s low down payment home buyers, there are scenarios in which the FHA loan is what’s best for financing; and there are scenarios in which a conventional loan is the clear winner. Rates for both products should be reviewed and evaluated.
If you’re ready to buy, talk with a loan officer about your mortgage options. You should compare personalized quotes for both FHA and conventional loans to see which one is most cost efficient for your situation and suits your needs best. Here at RMP, we can help you make the right decision.