There’s an app for everything these days. On one hand, it’s fantastic. On the other, it’s maddening. When you’re spoiled for choice, how do you know which option is the best one for your situation? Oddly enough, homebuyers sometimes find themselves struggling with a similar conundrum as they try to select the right mortgage for their needs from the many different home loan programs available. If you’re wondering whether a loan guaranteed by the Federal Housing Administration (FHA) or a conventional loan is right for you, exploring the difference between FHA and conventional loans can help you decide.
The Difference Between FHA and Conventional Loans
What is the difference between FHA and conventional loans? There are actually several. As Investopedia explains, conventional loans are loans that are not insured by the federal government. In contrast, an FHA loan is guaranteed by the Federal Housing Administration, which reduces the lender’s risk. What other differences should potential borrowers take into account when selecting a mortgage?
One of the best-known advantages of an FHA loan is the low down payment requirement. As The Truth About Mortgage reports, borrowers with a credit score of 580 or more only need to provide a 3.5 percent down payment. Borrowers with scores between 500 and 580 who manage to secure an FHA loan will need a 10 percent down payment. Either amount is noticeably lower than the 20 percent down payment many people believe buyers need to secure a mortgage. However, today’s conventional loans do not require a 20 percent down payment. In fact, borrowers with excellent credit can now secure a conventional mortgage with a down payment of just 3 percent. So either way, you can secure a loan without putting much money down.
When you want to buy a home to serve as your primary residence, an FHA loan is a possibility worth considering. However, FHA loans can only be used to purchase properties for that singular purpose (source). Conventional loans can be used to buy a primary residence as well, but they can also be used to purchase rental properties, commercial properties, vacation homes, and other investment properties.
Although FHA loans are backed by the government, the lenders originating the loans have their own standards when it comes to credit scores. Lenders also decide the minimum required credit score for conventional loans. Generally, FHA loans are easier to qualify for than conventional loans (source).
Have you had major credit problems in the past? You’ll likely find that an FHA loan is a more forgiving option than a conventional loan. Borrowers must be at least three years from a foreclosure and two years from a bankruptcy to secure an FHA loan. For a conventional loan, the window is larger. Borrowers must be seven years out from a foreclosure and at least four years from a bankruptcy (source).
As its name suggests, a debt-to-income ratio compares the total amount of your debts to the total amount of your income. For borrowers opting for an FHA loan, their debt-to-income ratio, including the new mortgage, must be 50 percent or less, according to Nerd Wallet. Conventional loans are a bit stricter. Borrowers using this form of financing generally must have debt-to-income ratios of 45 percent or less.
Your interest rate can have a major impact on the total cost of your loan. How do FHA and conventional loans compare? FHA loans generally have lower base interest rates than comparable conventional loans (source). However, would-be borrowers will need to crunch the numbers carefully. In many cases, the savings offered by the lower interest rate are gobbled up by the higher mortgage insurance premiums required with FHA loans.
FHA and conventional mortgages have very different requirements for mortgage insurance (source). Basically, FHA mortgages all demand FHA mortgage insurance in the form of both an upfront payment and a monthly premium that’s generally added to your monthly mortgage payment. If your down payment is less than 10 percent, that monthly premium will be required for the entire life of your loan. In contrast, not all conventional mortgages require mortgage insurance. Borrowers who put down 20 percent or more are typically exempt. If you put down less than 20 percent, you’ll likely be required to pay for private mortgage insurance until you build enough equity to have a loan-to-value ratio of 78 percent. Once that milestone is reached, the requirement for private mortgage insurance vanishes.
What does the difference between FHA and conventional loans mean for you? If you have questions about home loan programs or your mortgage options, our team is ready to help. Contact us today to schedule a consultation. The experienced loan officers at PrimeLending strive to make securing the right mortgage for your unique situation as simple and hassle-free as possible. At our branches located throughout Kansas City, we can help you explore our wide variety of loan products and programs, including VA loans. When you’re ready to get started, please give us a call at 844-701-5626.