FHA vs. Conventional Loans: A Comparison
When looking for a loan for home buying purposes, you will have many factors to consider and tough decisions to make. Which loan is right for you, how do you qualify, what do you need to be thinking about first, what are the options, and how are they different? Here are some insights into FHA and conventional loans and a comparison of the two to start your decision-making process.
There are many misconceptions concerning these two loan types. Many believe that FHA loans are only for first-buyers, while conventional loans are for buyers with an established history. Both of these scenarios could be the case for either loan type, but they are not the standards.
Each of these loans has specific requirements, and both have advantages and disadvantages. Here is an explanation of the basics for each loan and how they compare to each other to get you started on the right path in choosing FHA or conventional loans.
Tips for Comparing FHA and Conventional Loans
Beginning any discussion on comparisons between FHA and conventional loans must start with the area in which they differ the most; down payments and credit score or moreover the minimum requirements for both of these factors.
Down payments vary depending on the property you are buying and your credit score. For FHA loans, a person with a credit score of 580 or higher the down payment required will be approximately 3.5%. In contrast, conventional mortgage lenders may provide you with a lower down payment, around 3%, if you have a higher credit score. To receive this lower down payment, conventional lenders will want you to have a credit score of 620 or higher with savings to back it. Again, these rates vary dependent on the home you are buying and your personal credit score.
When it comes to credit scores, FHA loans are going to be a bit more lenient. In general, a person can qualify for an FHA loan with a credit score that is lower than that required by conventional mortgage lenders. With a credit score of around 580, a person would probably qualify for an FHA loan with a down payment of approximately 3.5%. If your credit score is lower that this, you may be eligible for a smaller down payment, than with traditional lenders, depending on your circumstances.
With conventional mortgage lenders, you will need a higher credit score to qualify for the loan, to begin with. Traditional mortgage lenders prefer a starting score of around 620. This does not mean you cannot qualify for a mortgage of this type, only that the process is more complicated and requires higher down payments and interest rates. Also, the higher the credit score with traditional lenders, the lower the interest rate that you will receive.
The debt-to-income ratio (DTI), is calculated as the percentage of your monthly income before taxes that you currently utilize for paying all of your bills. Both FHA and conventional lenders require this percentage to be less than 50% of your overall income. If you are paying more than 50% of your income towards bills, it shows that you may have issues staying ahead of your bills with this new loan. Also remember that while you may find some conventional lenders will accept a DTI of 50%, most generally they prefer that it is closer to 40% or less.
FHA Loan Limits
When it comes to loan limits, conventional and FHA loans alike have a limit on the amount a person can borrow. These limits will vary dependent on the regulations for each state and even county you may be buying in, and are also subject to change annually.
For 2019, the FHA loan limits range from approximately $314,000 to $726,500. These amounts are based on low-cost areas and more expensive areas, respectively. Conventional loans are governed by the restrictions imposed by the Federal Housing Finance Agency. The limit set for 2019 is approximately $484,350. As you can see, the limits that are offered by either loan type will vary depending on location, year, and regulatory restrictions placed on lenders.
More: FHA Loan Limits for 2019
When discussing mortgage insurance, it is vital first to understand what it is and what it does. Mortgage insurance is a protection policy that protects the mortgage lender in the event that you should default on the loan. With traditional loans, mortgage insurance is required if the downpayment on the loan is less than 20%. In contrast, with FHA loans, mortgage insurance is required on all loans no matter the amount of the down payment.
There are a few other notable differences in insurance requirements between FHA and traditional mortgages. One such difference is the cost of insurance. With FHA loans the insurance is going to cost the same no matter your credit score, whereas, with conventional loans, the amount of the insurance will be higher or lower in direct relation to your credit score. Another difference in mortgage insurance is the length of time a borrower is required to have this coverage. With an FHA mortgage loan, the borrower is required to have mortgage insurance for the life of the loan. The only way to remove this requirement is refinancing with a traditional loan. Conventional loans, on the other hand, only require insurance until the equity you have paid into the home reaches a certain level.
One aspect both of these loans have in common concerning mortgage insurance requirements, is that both insurance premiums will vary dependant on the size of the down payment made towards the loan.
When considering FHA and conventional loans one crucial factor to remember is the properties condition and what the property will be used for.
FHA loans require a more extensive appraisal that considers the properties value, sturdiness of construction, safety, and local code adherence. Conventional loans, however, take into account the value of the property and have limited requirements in their appraisals.
Another stark difference between FHA and conventional loans is that with an FHA loan, you must be using the property as your primary dwelling. In other words, this must be the house you are going to be living in. Investment homes, vacation homes, or any other type of homes do not qualify for FHA mortgages. In contrast, conventional loans are offered for investment homes, primary dwellings, or vacation properties. You are not required to live in the house to qualify for traditional loans.
Bringing it All into Terms
When deciding between an FHA mortgage loan or a conventional mortgage, there are some significant differences to remember.
FHA Mortgage Loans
- Borrowers qualify with a lower credit score.
- May require higher down payments depending on credit scores.
- Appraisal and usage policies are more stringent (Including primary dwelling requirements).
- Mortgage insurance is required for the life of the loan no matter the amount of down payment.
Conventional Mortgage Loans
- Borrower need to have higher credit scores.
- In some instances, down payments may be lower.
- Appraisal and usage policies are more lenient (can use for primary dwelling, vaction, or investment properties).
- Allows for mortgage insurance cancellation after a specific equity value has been reached.
- If you are unsure which options fits your needs and circumstances, speaking with a loan officer can answer any questions you still have. Each decision must be a personal one relative to the borrower’s situational needs.