It’s a given that some people believe FHA loans are only for first-time home buyers and conventional loan products are for experienced buyers. However, both loan options provide advantages for all buyers despite the differing qualification criteria.
The Federal Housing Administration backs FHA loans to help first-time home buyers and people with lower credit scores. In contrast, conventional loans are not government-insured but often require higher credit scores and larger down payments.
Interest rates matter when choosing between these two types of loans. FHA loans tend to have lower interest rates, but you need to pay mortgage insurance premiums (MIP) for the entire loan term. Conventional loans may have higher rates initially, but you won't need mortgage insurance if you make a down payment of 20% or more.
Monthly debt payments also impact your loan choice. FHA loans could mean lower monthly payments due to flexible approval rules. However, sellers prefer conventional loans since they have faster processing times with less paperwork and bureaucracy.
Knowing the key differences is crucial for people looking to buy a home. It helps them make smart choices that fit their money situation and future plans as homeowners.
What is an FHA Loan?
An FHA loan is a mortgage guaranteed by the Federal Housing Administration (FHA). FHA loans work as an agreement between the government and FHA-approved lenders.
If the borrower defaults, the government will pay the mortgage loan lender back a portion of the loan, which makes mortgage lenders more willing to lend to borrowers who would not be able to qualify for a conforming conventional loan. This is similar to VA loans, though there is no military service requirement for an FHA loan.
These loans help people with lower incomes or credit scores afford homes. They need smaller down payments than regular mortgages and have flexible requirements, making them a good choice for first-time homebuyers.
FHA products are a significant way to reduce racial disparity in homeownership rates, making them a crucial part of creating a more equitable world. In fiscal year 2023, 30.63% of these loans went to borrowers of color, which is much higher than the rate of conventional loan borrowing amongst people of color.
What is a Conventional Loan?
This type of loan is not backed by any government agency like the Federal Housing Administration (FHA), the Department of Veterans Affairs (VA), or the Department of Agriculture (USDA). Conforming mortgage loans, which are the most common type, can be purchased and repackaged by Fannie Mae or Freddie Mac for sale on the secondary mortgage market.
Private lenders, like banks and credit unions, provide and set the terms for these loans. It's worth noting that conventional loans do not have government insurance or guarantees.
Sadly, conventional loan products are often difficult for LGBTQ+ borrowers to access. In fact, a study found that same-sex couples were 73% more likely to be denied than heterosexual couples. Those that were approved were charged higher fees, like a higher interest rate, because lenders baselessly considered them riskier.
Conventional loan products are also more inaccessible for borrowers of color. The Federal Reserve Bank of Minneapolis found that Black applicants were twice as likely to be denied as White applicants, even when their financial profile was exactly the same.
This is why it’s crucial to work with companies like Pride Lending, who will serve as your advocate and assist you in finding products that meet your needs regardless of your identity. Whether you are seeking an FHA or conventional loan, we will help you find great home loan products and additional assistance, like down payment and closing cost assistance programs.
Key Differences
It's essential to know how FHA and conventional loan products are different when choosing the best loan option. Here, we explain the main differences between a conventional and FHA loan in terms of credit score requirements, down payments, mortgage insurance, and more.
Credit Score
FHA Loans
FHA (Federal Housing Administration) loans have more lenient credit score requirements, making them accessible for many borrowers. To qualify for the low 3.5% down payment, your credit score must be 580 or higher. If your score is between 500 and 579, you can still get an FHA loan but will need a bigger down payment of at least 10%.
Conventional Loans
Conventional loans have stricter credit score requirements than FHA loans. Most lenders require a minimum credit score of 620 for a conventional loan. But to get better terms and interest rates, you typically need a credit score of 700 or higher. These higher standards exist because lenders take on more risk without government insurance.
Down Payment
FHA Loans
FHA loans’ most attractive feature is the low down payment. With a 580+ credit score, you only need a 3.5% down payment. Scores from 500-579 require a 10% down payment. This lower barrier helps first-time buyers and those with less savings afford a home.
Conventional Loans
A conventional loan will require a higher down payment than an FHA loan. The minimum down payment can be as low as 3% for qualified borrowers, but it's often 5-20% of the home’s purchase price. A 20% down payment allows borrowers to avoid private mortgage insurance (PMI), which can be a substantial recurring expense.
Mortgage Insurance
FHA Loans
Borrowers have to pay mortgage insurance premiums for FHA loans, irrespective of the down payment. There are two types of FHA mortgage insurance premiums (MIP): an upfront MIP and an annual MIP.
The upfront MIP is usually 1.75% of the loan amount and can be added to the loan balance. The annual MIP ranges from 0.50% to 0.55% (unless the loan is greater than $726,200, in which case it is 0.70% to 0.75%) of the loan and is paid monthly. This mortgage insurance remains for the loan's entire term if the down payment is less than 10%. For loans with a 10% or higher down payment, the MIP is required for 11 years.
If you provide a 20% down payment, you will not have to pay FHA mortgage insurance premiums.
Conventional Loans
Private mortgage insurance (PMI) is necessary for conventional loans if the down payment is under 20% of the home's purchase price. Unlike FHA loans, PMI for conventional loans can be removed once the home owner's equity reaches 20% of the home's value.
This can happen through paying down the loan balance or home appreciation. PMI costs for conventional loans vary based on the borrower's credit score and down payment amount. Generally, it ranges from 0.3% to 1.5% of the original loan amount per year.
Qualifying for a Loan
When you're looking to buy a home, understanding the requirements for different types of loans is crucial. Each loan type has specific criteria you must meet to qualify. These include down payment amounts, credit score thresholds, debt-to-income ratios (DTI), and other factors like mortgage insurance. Let's break down the requirements for FHA and conventional loans.
FHA Loan Requirements
Down Payment
FHA loans require a minimum down payment of 3.5% of the home's purchase price if you have a credit score of at least 580. If your credit score is between 500 and 579, you will need a down payment of 10%.
If you’re struggling to save up this down payment amount, Pride Lending can help. We’ll search for local, state, and nationwide down payment assistance programs that will make up the difference between your savings and what lenders expect, helping to reduce barriers to home ownership.
Credit Score
To qualify for the 3.5% down payment rate, you need a minimum credit score of 580. Borrowers with credit scores between 500 and 579 must make a higher down payment.
Debt-to-Income Ratio
The FHA typically allows for a maximum DTI of 43%, although some lenders may accept higher ratios depending on your overall credit profile.
Loan Limits
FHA loan limits vary by location and are set based on the county in which the property is located. In most areas, the limit is $498,257 for a single-family home, but it can go up to $1,149,825 in high-cost areas.
Mortgage Insurance
FHA loans require two types of mortgage insurance. First is the Upfront Mortgage Insurance Premium (UFMIP), which is 1.75% of the loan amount. Second is the Annual Mortgage Insurance Premium (MIP), which ranges between 0.50% and 0.55% (except for loans greater than $726,200, in which case it is 0.70%-0.75%) of the loan amount, depending on the loan term and loan-to-value ratio.
Conventional Loan Requirements
Down Payment
Conventional loans typically require a minimum down payment of 3% to 5%, depending on the lender's guidelines and the loan program.
Credit Score
A minimum credit score of 620 is generally required to qualify for a conventional loan. A higher credit score can lead to better interest rates and loan terms.
Debt-to-Income Ratio
The maximum DTI for a conventional loan is usually 45%, though some lenders may allow up to 50% with strong compensating factors.
Loan Limits
For 2024, the conforming loan limit for a single-family home is $766,550 in most areas, but it can go up to $1,149,825 in high-cost areas.
Mortgage Insurance
Conventional home loans require mortgage insurance if you provide less than a 20% down payment. The cost of PMI varies but typically ranges from 0.3% to 1.5% of the original loan amount per year, depending on the size of the down payment and the borrower’s credit score.
Loan Costs
When securing a mortgage, it's essential to understand the associated costs beyond the down payment. Both FHA and conventional loans come with various fees and insurance requirements that add to the overall cost of borrowing.
FHA Loan Costs
Upfront Mortgage Insurance Premium (UFMIP): This is 1.75% of the loan amount and is typically financed into the loan.
Annual Mortgage Insurance Premium (MIP): This typically ranges between 0.50% and 0.55%, unless the loan is greater than $726,200, in which case it ranges from 0.70% to 0.75%.
Closing Costs: These usually range from 2% to 5% of the loan amount and include fees for the appraisal, credit report, title search, and other services.
Conventional Loan Costs
Private Mortgage Insurance (PMI): Required if your down payment is less than 20%. PMI costs range from 0.3% to 1.5% of the original loan amount annually and are added to your monthly mortgage payment.
Closing Costs: Typically, these range from 2% to 5% of the loan amount. Closing costs include lender fees, appraisal fees, title insurance, and other expenses associated with processing the loan.
Loan Features
When choosing between FHA and conventional loans, it's necessary to understand the features and benefits of each. Here's what you should know.
FHA Loan Features
Assumable Loans
One thing about FHA loans is that they are assumable. This means that if you sell your house, the buyer can take over the FHA loan on it and might benefit from lower interest rates that you had on it. This can be a huge selling point in environments where rates are high.
More Lenient Appraisal Guidelines
Appraisal guidelines for FHA loans are more lenient than those for conventional loans. This flexibility makes it easier for buyers to qualify since FHA loans do not have very strict property requirements.
Streamline Refinance Options
Streamline refinance options are available for FHA loans, allowing borrowers to refinance their existing FHA loan to a lower rate without much paperwork and needing a new appraisal. Consequently, this will save a lot of money on the monthly mortgage payments. The faster approval means you can jump on the best FHA loan interest rates as soon as they become available.
Conventional Loan Features
No Initial MIP
One significant benefit of conventional financing over its FHA counterpart is the absence of upfront mortgage insurance premiums (MIP). Such a requirement can make starting the loan process unnecessarily expensive.
Potentially Lower Rates of Interest
Conventional loan interest rates are sometimes lower for well-qualified borrowers. Typically, individuals with good or excellent credit histories secure lower interest rates when borrowing money through traditional channels, such as banks offering non-government-insured home loans. This can translate into significant savings over the life of the loan.
PMI Cancellation
In addition, private mortgage insurance (PMI), which is associated with conventional loans, can be canceled once a homeowner has reached 20% equity in their property. In contrast, FHA mortgages generally require you to pay mortgage insurance for the entire term unless a significant down payment was made at the outset.
More Flexible Loan Options
Conforming loans and non-conforming (jumbo) loans are available under conventional mortgage guidelines, providing more options for borrowers. The latter group permits financing beyond the limits set by the Federal Housing Finance Agency, catering to higher-end real estate markets. In many cases, sellers prefer conventional loans because they are flexible.
When to Choose FHA Loans
Understanding all there is to know about home loans can be challenging and confusing. This is especially true when choosing between FHA and conventional loans. FHA loans are backed by the Federal Housing Administration and have exclusive advantages that suit different financial situations. Below are circumstances under which you should consider this type of mortgage.
Lower Credit Score (500-619)
If you have a low credit score, an FHA loan could be a great option. Typically, conventional mortgages require higher scores than those required by government-backed loans.
For example, securing such a loan may be hard if you have a credit rating between 500 and 619. Nevertheless, FHA loans are designed to accommodate borrowers with lower credit scores. This means getting your own house might not necessarily require you to have that high credit score common with conventional loans.
Limited Down Payment (as low as 3.5%)
FHA loans allow an applicant to make the least possible down payment equal to 3.5% of the required amount. This feature is most beneficial for people who are buying their first homes or do not have much savings.
For instance, you find a nice house but only have enough saved for a small down payment. With this kind of mortgage, you can still buy the property without necessarily meeting the higher down payment requirement typical of conventional loans. This makes owning homes easier because of its flexibility in terms of down payments.
Less Strict Debt-to-Income Ratio
Debt-to-income ration is your monthly gross income compared to your debt service, such as credit cards and student loans.
Compared to conventional loans, FHA loans also have more lenient debt-to-income (DTI) ratio requirements. Typically, conventional loans require a lower DTI ratio- which can be difficult to achieve if you have a huge amount of existing debt.
FHA loans generally may be suitable if your monthly debt payments are a high proportion of your income. It considers that life happens and has a more accommodating approach to DTI ratios. Therefore, one can still qualify for this mortgage even in a less-than-ideal financial position.
First-Time Homebuyers
First-time homebuyers often face many obstacles, from understanding mortgages to saving up for a large down payment. FHA loans are designed with a lower credit score and less down payment in mind, so they might just be what you need if you’re stepping into the housing market for the first time.
When to Choose Conventional Loans
When deciding whether to go for an FHA loan or a conventional one, you must consider several things, such as your financial status, credit score, and what you want to achieve in the long run.
People go for conventional loans mostly if they meet specific requirements that align with the benefits these loans offer. Here’s when you might consider a conventional loan:
Higher Credit Scores (620+)
It would probably make more sense for someone with a higher credit score ( ~620 and above) to go for a conventional loan instead of the FHA-insured mortgage. For example, suppose you’ve put so much effort over time towards building a good credit history with a strong credit history.
Chances are that with a 700-point score, the interest rates charged on your loan will most likely be lower than what they could offer if it were backed up through their program, which ultimately makes it a more cost-effective choice in the long run.
Larger Down Payment (20% or more to avoid PMI)
Choosing a traditional home loan can be beneficial if you have the means for a larger down payment – around 20% or more. For instance, assume you have saved enough money and can pay 20% when buying your new house. When you do this, you will not need to pay Private Mortgage Insurance (PMI), which could significantly reduce your monthly mortgage payments. This situation suits borrowers who wish to cut down on extra costs associated with their mortgage.
Lower Debt-to-Income Ratio
A debt-to-income ratio is a key factor that conventional loan creditors use to assess your creditworthiness. If you have a stable income and minimal outstanding debt, you will be well-placed to benefit from the lenient limits for debt-to-income ratios when seeking approval for conventional loans.
On the contrary, FHA loans may have more stringent requirements with regard to these limits, making them relatively expensive options.
Refinancing or Second Home
Conventional loans are often the go-to option for refinancing or purchasing a second home. For example, consider you’re looking to refinance your current mortgage to take advantage of lower interest rates, or you’re interested in buying a vacation home.
Conventional loans offer more flexibility and better terms for these purposes compared to FHA loans, which are generally more restrictive regarding second homes and refinancing conditions.
Additional Differences of FHA and Conventional Loans
When you're comparing FHA vs. conventional loans, you need to know what makes them different because that could have a major effect on how you borrow money. Both types of loans are ways to buy a home but have various distinctions that set them apart.
Property Requirements
FHA loans, which are insured by the Federal Housing Administration, generally have stricter standards for properties than conventional ones do. To get approved for an FHA loan, a house must meet the safety, security, and soundness criteria this agency sets.
In other words, an FHA appraisal is needed where inspectors come and check if everything’s in check. Things like structural damage or safety hazards must be fixed before they lend you money. You typically can only use an FHA loan for a primary residence, though this can be a multi-unit property where you rent out a portion of the property.
Conversely, conventional loan products typically have more lenient property requirements, focusing more on the market value and less on the detailed condition of the home. This flexibility can benefit borrowers looking at more properties, including fixer-uppers. You can also use these loans for any property, including an investment property.
Loan Limits
Another major difference between FHA and conventional loans is loan limits. They are set by the FHA and differ from county to county. These limits depend upon the average home prices in a certain area, meaning they could be higher where real estate markets are more expensive.
For example, in high-cost regions, FHA loan limits may go way above the national baseline. Conventional mortgages also have location-based restrictions regulated by the Federal Housing Finance Agency (FHFA).
However, they generally offer larger maximum borrowing amounts than what is obtainable with an FHA loan. These are referred to as conforming loan limits and they make it possible for people who need big loans to consider conventional ones.
To sum up, the conventional loan limit is higher than the FHA loan limit in each specific county, marking a significant difference between FHA loans and conventional mortgage products that you must consider based on your budget.
Seller Concessions
Seller concessions refer to the amount a seller can contribute towards the buyer’s closing costs. FHA mortgages let sellers pay more closing costs than conventional loans. With an FHA loan, sellers can pay up to 6% of the home's price for closing costs. These costs include upfront mortgage insurance, prepaid taxes, and insurance premiums. For conventional loans, sellers can pay up to 3% of the price if the down payment is less than 10%. They can pay up to 6% if the down payment is between 10% and 25%. And they can pay up to 9% if the down payment is over 25%. Seller concessions make it easier for buyers with limited cash to cover closing costs.
Summary
Borrowers must consider their money when choosing between conventional and FHA loans. FHA products are better for people with low credit scores, high debt, and little savings for a downpayment.
The government backs these loans, so they have easier qualifying rules. FHA loans let people buy homes with a down payment as low as 3.5%, helping first-time buyers and those with less cash.
On the other hand, regular loans work well for borrowers in good financial shape. If you have a high credit score, low debt, and enough saved for a big down payment, a regular loan may be best. Private lenders give these loans with stricter rules since no government backing exists.
But regular loans can offer lower interest rates. With a 20% down payment or more, you can avoid paying for mortgage insurance. Additionally, regular loans provide more flexible terms.
Ultimately, choosing an FHA or conventional loan depends on your credit, income, and savings situation.
Pride Lending is here to serve as your ally throughout the mortgage process. Our team is composed of allies or members of marginalized communities, including LGBTQ+ and BIPOC individuals, who all understand the challenges that face homebuyers in today’s market. We serve clients from all walks of life, ensuring that everyone has access to the financing they need to reach their goals.
If you need guidance or more details about credit scores and mortgages, contact us at Andrew@PrideLending.com or call us at 725-780-5001 today!
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