FHA loans will work with people that have lower credit scores and have fewer qualifications. A conventional loan would require that a person have a lower down payment rate.
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FHA is usually for first-time homebuyers while a conventional mortgage is for those that have gone through the process before.
This is not always the case.
The Federal Housing Authority will insure the FHA loans. Conventional mortgages are not federally managed.
How to compare these loans
The first thing to consider is the down payment amount and your credit score. There are different requirements for these loans.
Minimum Down Payment
FHA loans require at least 3.5 percent of the purchase price down and the minimum credit score is 580. Some conventional lenders will allow 3 percent down but this is for people with higher credit scores and more savings funds.
Credit Score
FHA loans will allow a person to have a credit score as low as 580. If your score is 500 to 579 you may need to put 10 percent of the purchase price down with this loan.
A conventional loan requires a credit score of at least 620.
With either loan the lender will determine the credit score they are willing to work with. Lenders can require a higher credit score. The better your credit score is the lower your interest rates will be.
Debt to Income
Your debt it income ratio is your income before taxes that is spent on debt. This debt includes a mortgage, student loans, car loans, and even credit card payments. The more debt you have the harder it is to pay your bills.
To get an FHA loan your debt to income ratio must be less than 50 percent. Conventional loans may allow up to 50 percent. You have a better chance for approval if your debt to income ratio is below 43 percent.
Mortgage Insurance
Mortgage insurance will protect the lender if you happen to default. A conventional loan will require that a borrower carry this insurance if they are putting less than 20 percent down. FHA requires this for all borrowers regardless of down payment. There are some others things to keep in mind.
Other differences between the mortgages include:
FHA will have the same insurance cost regardless of credit score. Some private lenders will increase your costs if you have a low credit score. This will still be less than FHA cost especially if you have a credit score above 720.
FHA will require insurance for the duration of the loan if the down payment is less than 10 percent. If you make a down payment of above 10 percent you will need to have mortgage insurance for 11 years.
If you refinance to a conventional loan you will not have to pay the FHA mortgage insurance. You can cancel private mortgage insurance once you paid 78 percent of the purchase price.
For both types of loans, the mortgage insurance will vary based on the size of the down payment.
Limits
There are limits to the amount of money that you can borrow. There are different regulations based on where you are living.
The 2021 FHA limit was $356,362 in lower cost areas and $822,375 for higher markets. The Federal Housing Industry requires that conventional loans meet their regulations. If the loan amount was over $548,250 the loan is said to be a jumbo loan.
The Property
FHA has strict regulations when it comes to the property. The property will need a value assessment and it needs to meet certain safety regulations. The residence must be your primary home. If you are going to use the property for an investment property you cannot get an FHA loan.
A conventional loan can be used for your primary residence, a vacation home, or an investment.
Refinancing
FHA loans have to streamline refinancing. It is easy to get with no income verification, credit card, and no appraisal. While this sounds too good to be true it is. There are some tough requirements.
If you refinance an FHA loan you do not have to carry mortgage insurance. You will need to have equity of 20 percent to refinance this loan.
Summary
There are some main differences between conventional and FHA loans.
Conventional loans require:
A higher credit score
Smaller down payment
Have flexible standards
If the down payment is less than 20 percent private mortgage insurance is needed
FHA loans:
Lower credit score
Smaller down payment
Property must meet safety requirements
Mortgage insurance is needed regardless of the down payment.
If your credit score is less than 620 there is a good chance you will not qualify for a conventional mortgage. FHA loans are a good option. If you have a credit score of at least 720 you can get a conventional loan and save on monthly costs. If your credit score is less than 720 an FHA loan is your best option.
If you are not sure which one is best for your needs you should speak to a mortgage loan officer.
If you are serving or have served in the military you can get a VA backed loan. They do not require a down payment. If you live in a rural area you may look into a USDA loan.
Frequently Asked Questions
Which loan is the best?
You will need to look at your finances to determine which loan is best for you. If you have credit issues, high debt to income rate, or a low down payment you will want to go with an FHA loan. If you are financially stable you may want to go for the conventional mortgage.
Why do sellers like conventional loans over FHA?
FHA loans will require an FHA appraisal. Sellers need to address safety issues and make repairs. Some sellers do not want to do this.
Which loan is more expensive?
This will depend on how much you are borrowing and the size of the down payment. You can use a mortgage calculator to get an estimate of your monthly payments. Keep in mind an FHA loan is going to require mortgage insurance.
