FHA Loans or Conventional Loans: Which is Best for You?

FHA Loans or Conventional Loans: To get a mortgage and buy a home sooner, FHA is the best but they come at a cost. If you can qualify for a conventional mortgage instead, you may save thousands over the life of your loan.

FHA vs. Conventional Loans

An FHA loan allows for lower credit scores and can be easier to qualify for.  On the other hand, conventional loans may not require mortgage insurance with a large enough down payment.

So in the end, the benefit of one over the other comes down to the individual needs of the borrower.

In this article:

FHA Loans

FHA loans are home loans backed by the Federal Housing Administration (FHA), a government agency created to help home buyers qualify for a mortgage.

The FHA provides mortgage insurance on loans made by FHA-approved lenders, protecting them from the risk of borrower default.

Because lenders are protected, they can afford to be more lenient when offering mortgages. For example, this means it’s possible to get an FHA loan with a lower credit score than other types of loans.

To offset this, FHA loans will typically include mortgage insurance as part of the borrower’s responsibility.

Pros and Cons Of an FHA Loan

Pros and Cons Of an FHA Loan

Pros

  • At Quicken Loans, FHA loans are available with a credit score of 580 and a down payment as low as 3.5%.
  • You may qualify for an FHA loan after a foreclosure or bankruptcy if you’ve maintained good credit.
  • You can use gift money to cover up to 100% of the down payment.

 Cons 

  • You’ll have to pay an upfront mortgage insurance premium (MIP) as well as an annual MIP, which is included in your monthly mortgage payment.
  • FHA loans are not available for second homes or investment properties.
  • In most counties, the FHA loan limits are less than conventional loans.

Conventional Loans

Conventional loans are the most common types of loans in the mortgage industry. They’re funded by private financial lenders and then sold to government-sponsored corporations, Fannie Mae and Freddie Mac.

These loans have stricter requirements than FHA loans. You’ll need a higher credit score and a lower debt-to-income ratio to qualify for a convention

Pros and Cons Of A Conventional Loan

Pros

  • You can make a down payment as low as 3%.
  • If your down payment is at least 20%, you can avoid paying private mortgage insurance (PMI).
  • In most counties, you can typically borrow more than you can with an FHA loan.
  • Mortgage rates are typically lower for conventional loans than FHA loans.

Cons 

  • You’ll have to pay PMI if your down payment is less than 20% of the loan amount.
  • The loan qualifications are stricter, requiring a minimum credit score of 620 and a lower DTI ratio. al loan than you would with an FHA loan.

Comparing FHA With Conventional Loans

FHA vs. Conventional Loans

Both types of loans have their advantages. Here are the factors to consider when deciding between an FHA and a conventional mortgage.

Down Payment

You can get an FHA loan with a down payment as low as 3.5 percent. Though some conventional mortgages have a down payment requirement as low as 3 percent, most typically require a down payment of 5 to 20 percent, according to the Consumer Financial Protection Bureau.

Mortgage Rates

Another distinction for FHA loans: generally lower mortgage interest rates. However, the difference between the two was incremental last year.

The 30-year fixed-rate for FHA purchase loans closed in 2016 averaged 3.95%, compared with a conventional mortgage rate on the same term of 4.06%, according to Ellie Mae.

Refinancing

As far as mortgage refinancing goes, the edge goes to FHA “streamline” refinancing. With no credit check, no income verification, and likely no home appraisal, it’s about as easy a refi as you can get. But there are five requirements for an FHA streamline refinance.

Loan limits

Where you’re planning to buy your home can play a role in what kind of loan is best for you. FHA and conventional loan guidelines allow wide latitude for borrowers in expensive areas.

But in some cases, you may end up needing a jumbo loan, which is bigger than FHA or conventional limits.

FHA loans are subject to county-level limits based on a percentage of a county’s median home price. In certain high-cost areas, the limit in 2018 can be as high as $679,650 — and in Alaska, Guam, Hawaii and the Virgin Islands, limits can be much higher than that.

For loans guaranteed by Fannie Mae and Freddie Mac, the government-sponsored companies that help fund the conventional mortgage industry, single-family home loan limits in 2018 are $453,100 in most of the country. Again, higher loan ceilings are available in pricier counties.

Mortgage Insurance

With a down payment of less than 20%, both FHA and conventional loans require borrowers to pay mortgage insurance premiums. This insurance helps defray the lender’s costs if a loan defaults.

There are some differences between the two insurance programs.

With an FHA loan, if you put less than 10% down, you’ll pay 1.75% of the loan amount upfront and make monthly mortgage insurance payments for the life of the loan.

With a down payment of 10% or more (that is, a loan-to-value of 90% or better), the premiums will end after 11 years.

Conventional loans with less than 20% down charge private mortgage insurance. It can be charged as an upfront expense payable at closing, or built into your monthly payment — or both. It all depends on the insurer the lender uses.

Credit Score Standards

FHA loans are easier to qualify for, with a minimum credit score of 580 to be eligible to make a 3.5% down payment. If your credit score is 500 to 579, you may qualify for an FHA loan with a 10% down payment.

Conventional loans typically require a credit score of 620 or higher, says Joe Parsons, a senior loan officer with PFS Funding in Dublin, California. He adds that a lower credit score often comes with a higher interest rate for a conventional loan.

Debt-To-Income Ratios

HUD’s Sullivan says your debt-to-income ratio — including the new mortgage, credit cards, student loans, or any other monthly obligations — must be 50% or less for an FHA loan. Ellie Mae reports the average debt ratio for borrowers closing FHA purchase loans in 2016 was 42%.

Conventional loans usually require a debt-to-income ratio no higher than 45%, Parsons says. In 2016, borrowers with conventional purchase loans averaged a 34% debt ratio, according to Ellie Mae.

Purchase Restrictions

Conventional loans can be used to purchase a vacation home, investment property or primary residence. FHA loans are limited to owner-occupied properties, which can include multi-unit properties as long you live in at least one of the units.

Read Also:

FHS vs Conventional Loan Summary

FHA Loans

  • Lower credit scores allowed
  • More rigid property standards
  • Somewhat higher down payment needed
  • Private Mortgage Insurance (PMI) is required for down payments of less than 20%

Conventional Loans

  • Higher credit score needed (at least 620)
  • Slightly smaller down payments allowed
  • Private Mortgage Insurance (PMI) is required for down payments less than 20%
  • More liberal property standards

1. Who are FHA loans for?

FHA loans for are best for borrowers who are looking for a minimal down payment and who may have trouble getting approved elsewhere. Further, it will be important that the house you want to buy, falls within the mortgage limits.

2. What Is A FICO Score?

A FICO score is a credit score developed by Fair Isaac & Co. Credit scoring is a method of determining the likelihood that credit users will pay their bills. Credit scoring is widely accepted by lenders as a reliable means of credit evaluation.

3. How do you qualify for an FHA loan?

To qualify for an FHA loan, you will need to shop around and select an FHA-approved lender that best suits your needs. You will have to meet the lender’s and the FHA’s eligibility requirements to get approved.

4. What Types of Homes Can I Purchase With Conventional Financing?

Conventional loans allow you to purchase single family homes, condos, investment properties, townhomes, lofts and 2nd vacation homes.

5. How long does it take to close an FHA loan?

Many factors can influence the closing time of a loan. However, according to Ellie Mae, FHA loan closing times average around 50 days.

If you meet the requirements for both an FHA loan and a conventional loan, take time to compare total costs. You can use a mortgage loan calculator to help see which loan will better serve your financial needs.

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