Difference between FHA Loans and Conventional Mortgage Loans

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June 14, 2018
Differences between FHA and Conventional Loan

If you are searching for a loan to buy a new home, you will find yourself weighing the two popular loan options: FHA and a conventional loan. What is the difference between the two and which one would be the right option for you?

While most of the home buyers assume that they should acquire a conventional mortgage, about 40 percent end up getting FHA home loan, which the Federal Housing Administration insures. Here’s some detailed information about the two loan options to help you decide whether you should choose an FHA home loan or opt for a conventional loan.

Conventional Loans

Take a look at the following statements:

  • Your credit score is 620 or more.
  • You can afford to pay a generally larger amount in down payment (3 percent to 20 percent and more)
  • You plan on putting a down payment of 20 percent to avoid private mortgage insurance (PMI)
  • You have a good income (high debt-to-income ratio)
  • You are purchasing a high priced house (Over $294,515)

If at least three of the above-mentioned statements are applicable to you, then it means that you may be able to qualify for a conventional loan.

Conventional Mortgage can be Cheaper

If you are planning to put a down payment of 20 percent to avoid private mortgage insurance, you must get a conventional mortgage loan, because mortgage insurance is required with FHA home loans regardless of how much is put in down payment.

If you can afford a down payment of 20 percent and are looking for an 80 percent loan-value mortgage then we suggest you choose conventional financing because it will be cheaper for you than FHA loan.

Pros of Conventional Mortgage

With a conventional mortgage, you can get higher mortgage amounts; usually, the maximum amount you can get through a conventional loan is $453,100. Moreover, there is no up-front (PMI) insurance in the conventional mortgage if you are putting 20 percent down-payment. When the loan-to-value ratio reaches 78 percent, the PMI payments are canceled and there is also no PMI, if the loan-to-value ratio is 80 percent. Three percent down payment is required for 97 percent loan-to-value ratio loan. Mortgage insurance in a conventional loan is less expensive; for a conventional loan it is 0.51 percent while for FHA home loan it is 0.85 percent.

Cons of Conventional Mortgage

With a conventional loan, often reserve funds are required. The required credit score is 620 which is higher than what is required for the FHA loan. The 3 percent to 20 percent down-payment is large and it can hard for home buyers to put such amount in down payment. The interest rates are generally higher in a conventional mortgage, particularly if your credit score is below 700, and it is more difficult to qualify for a conventional mortgage than FHA loan.

FHA Loans

In 1934, the government created the Federal Housing Administration to increase ownership of homes in the United States. The FHA loans are insured by the FHA. The best thing about FHA home loans is that home borrower can qualify for them more easily than conventional loans.

FHA realizes that not everyone can afford to pay a hefty down payment and has a great credit score, therefore it introduced FHA loan where home buyers don’t need these things to qualify for a home loan. If you don’t have funds to pay a down payment or have a low credit score, FHA home loans are an ideal option for you.

Home buyers can qualify for an FHA home loan with a 10 percent down payment if they have a credit score of 500 to 579. However, closing on an FHA loan with a credit score in this range is quite difficult and those home buyers who have a credit score below 580 and want to make certain that they qualify for an FHA loan should increase their credit score before they apply for an FHA home loan. With a credit score of 580, it is easier to qualify for an FHA loan. You’ll also only need to pay a down payment of 3.5 percent. Conventional loans prove to be cheaper than FHA loans in the longer run, but up-front FHA loan is cheaper because the down payment required is low.

Pros of FHA Loans

For an FHA home loan, reserve funds aren’t required. The down payment required is low (3.5 percent with a credit score of 580). Getting approved for an FHA home loan is much easier than a conventional mortgage. A low credit score is not a problem as FHA accepts credit score of 580 or higher. The interest rate on FHA mortgage is generally lower than a conventional mortgage, particularly if your credit score is below 700.

Cons of FHA Loans

The maximum loan you can get through FHA financing is lower than what can be acquired with conventional loans. Both an upfront and monthly mortgage insurance premium is required for the loan’s life regardless of how much money you put down.

Requirements for Minimum Credit Score

The most important factor in getting a home loan is the credit score and you’ll get better rates if your credit score is high. For both conventional loan and FHA loan, a credit score of 620 is best. If your credit score is less than 620, FHA might be a more viable option for you. A 500 to 579 credit score is required by FHA with a down payment of 10 percent. And if your credit score is 580 or more, you can get an FHA loan with a 3.5 percent down payment. The guidelines of FHA loans are more flexible than conventional loans which make them a better option for those who have a poor credit.

FHA Loans are Great for First-time Homebuyers

The conventional mortgage is although more popular than FHA loans, but first-time homebuyers mostly used FHA loans because of their low down payment and credit score requirements. Moreover, with FHA, gift funds can be used for 100 percent of your down payment while this isn’t allowed with most conventional mortgages. Assistance programs for down payments and first-time homeowner grants are also there that can be used for an FHA home loan. Conventional loans typically don’t permit funds of down payment coming from anywhere else except the borrower.

Private Mortgage Insurance and Mortgage Insurance Premium

In order to ensure the loan against foreclosure, an annual fee is added onto the payment of a loan. This fee is called mortgage insurance premium (MIP). Mortgage insurance premium is required with FHA home loan even if you are putting a down payment of less than 20 percent. The Federal Housing Administration acts as an insurer and if the property experiences a foreclosure, it pays the lender. The amount of MIP varies in FHA loan, but it is usually 0.85 percent of the total amount of the loan.

Mortgage insurance is also there in a conventional loan and it is called PMI or private mortgage insurance. However, PMI on a conventional loan is only required when you are putting a down payment of less than 20 percent. PMI is typically 0.5 percent of the total amount of the loan.

How Much Can Be Borrowed?

Limits of Conventional Loans

The limit of conventional loan is $453,100 in most of the areas of America. However, in certain areas where the home prices are higher, the limit on the conventional loan is increased to $625,000. The limit on the loan increases with the increase in the number of units. If you require a loan greater than the limit of conventional loans, you’ll need to get a Jumbo loan. With jumbo loans, you can get a loan of up to 3 million. But, for this loan you must have a credit score of 700 and you must put a down payment of 15 to 20 percent.

For a 1-unit home, the conventional loan limit is $424,100. For a 2-unit home, the loan limit is $543,000. For a 3-unit home, the loan limit is $656,350. For a 4-unit home, the loan limit is $815,650.

Limits of FHA Home Loan

The limits of FHA home loan are lower than conventional loans and in most of the areas of the United States the limit is $294,515. In certain areas where the costs of homes are higher, the limit of FHA home loan increases.

For a 1-unit home, the FHA loan limit in normal cost area is $294,515 while in high-cost locations it is $636,150. For a 2-unit home, the loan limit in normal cost area is $352,950 while in high-cost locations it is $814,500. For a 3-unit home, the FHA loan limit in normal cost area is $426,625 while in high-cost locations it is 984,525. For a 4-unit home, the loan limit in normal cost area is $530,150 while in a high-cost area it is $1,223,475.

FHA and Conventional Mortgage DTI Ratio

One of the major factors in determining the amount you can borrow is your DTI (debt-to-income) ratio. This is the percentage of your total monthly income after subtracting monthly obligations. Guidelines of FHA are much more lenient about maximum DTI ratios.

The maximum debt-to-income ratio required with FHA loan is 56.9 percent. The maximum debt-to-income ratio with a conventional mortgage is 50 percent.

Adjustable Rate and Fixed Rate Mortgage

With both FHA loan and a conventional loan, you can get a 15-year adjustable rate or fixed rate mortgage. More options are available with conventional loans such as a 10, 15, 20, 25, 30 and 40 year fixed rate loan. An adjustable mortgage is also available such as a 5-1 adjustable rate mortgage. Interest rates are lower in adjustable rate loans than fixed-rate mortgage and the monthly payments are also lower. After the initial 5-year period, the monthly payments and interest rate increase annually.

What Can You Buy through an FHA Loan?

Properties eligible for an FHA loan include manufactured homes, townhomes and condos approved by the FHA, semi-detached and detached homes and single-family homes.

What Can You Buy through a Conventional Loan?

With a conventional loan, you can buy semi-detached and detached homes, homes which need repairs, townhomes and condos and single-family homes.

Refinancing

You can refinance your loan to acquire better interest rate and lower loan payment in both conventional and FHA home loans.

Conventional Refinancing

For conventional loans, there is a rate and term conventional refinance option. With this option, the rate of interest will get low and the term can either be shortened or extended. Another option available for a conventional loan refinance is the HARP program with which you can refinance a loan owned by Freddie Mac or Fannie Mae regardless of how much equity you have.

FHA Refinancing

With an FHA home loan, you have an option of an FHA streamline refinance. An FHA streamline refinance is similar to traditional refinancing but requires less paperwork. There isn’t any income verification or credit check. With a quick and easy streamline refinance, you can get lower interest rate and reduce your payments.

Final Thoughts

Now that you know all the details of both conventional loans and FHA loans, which one do you think would be right for you? As you can see, the loan option that is right for you depend on your financial condition. If you can afford to pay a large down-payment and have a good credit score, then the conventional loan may be the best option for you. However, if you don’t have a good credit score and can’t afford to put a large down-payment, you should consider applying for an FHA home loan.

If you have been denied a home loan or have any questions about real estate or mortgage please contact the author, Matt Herbolich, MBA, JD, LLM by phone or text at 786.390.9499 or by email at mherbolich@usa-mortgage.com. Mr Herbolich works when you work, so feel free to contact him any time.

Matthew Herbolich
Matthew Herbolich
Mr. Herbolich is a Senior Loan Officer at USA Mortgage, a division of DAS Acquisition Company, LLC NMLS 227262. He is an expert not only in lending but multiple facets of real estate, particularly the title industry. Matt Herbolich trains his fellow loan officers on title industry topics, real estate investing, and countless mortgage guidelines. Have any questions? Call at 888-900-1020 or send email to: mherbolich@usa-mortgage.com

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