FHA Loan vs Conventional Loan
When trying to assess whether an FHA loan or a conventional loan (often referred to as a conventional mortgage) is more suitable for you, there is a need to understand how different loan features can affect your financial standing.
As every individual’s circumstances vary from one to another, the only way to make the right decision when it comes to taking out a loan is to either:
- Learn how each loan feature personally affects you
- Consult with a professional mortgage broker who will do all of the assessments for you.
The most important thing to bear in mind is that there is a huge potential to save thousands of dollars by simply choosing the right home loan package for you.
What is a Conventional Loan?
Conventional loans meet the Fannie Mae and Freddie Mac guidelines (both of which are quasi-public government agencies) and are offered by private lending institutions without being insured by the federal government.
Conventional loan requirements are not as flexible as government loan requirements. This type of loan is frequent among real estate investors because government-backed FHA loans can only be used for homeowners looking to purchase an owner-occupied home.
Note: A conventional loan is often referred to as a conforming loan because it qualifies as such. However, not all conforming loans are conventional loans. Like how all squares are rectangles, but not all rectangles are squares.
What is an FHA Loan?
FHA loans are the most popular home loans utilized by first-time property buyers. The FHA loan eligibility criteria is more flexible than other loan packages. FHA loans have a low credit score requirement for all types of mortgages and down payments for FHA loans can be gifts from friends or family.
FHA loans have lower interest rates than conventional loans because FHA loans are safer for lenders. However, you have to pay premiums on the FHA mortgage insurance in addition to your mortgage payment.
In many cases, especially with a small down-payment or a low credit score, the lower interest rates outweigh the higher cost of mortgage insurance.
What is a Conforming Loan?
A conforming loan is a loan that meets the guidelines issued by Fannie Mae and Freddie Mac. As explained in the Federal Housing Finance Agency’s website, both agencies help in providing “liquidity, stability, and affordability to the mortgage market.”
In order to securitize virtually any mortgage, conforming guidelines were created to help Fannie Mae and Freddie Mac assess which mortgages could be safely purchased. These guidelines factor in the credit score and history of the borrower, the debt to income ratio (DTI), the mortgage’s loan to value ratio, and the size of the loan.
What is a Jumbo Loan?
A jumbo loan is a non-conforming loan that exceeds the conventional loan limit. Due to the higher loan amount, jumbo loan requirements will be more difficult to satisfy compared with a conventional loan.
Jumbo loans are used to buy large or luxury homes and are not typically used by first-time homebuyers.
Now, to get to the fun part of assessing the comparison between an FHA Loan and a Conventional Loan.
FHA Loan vs Conventional Loan Comparison Table
This table will help you visualize the implications of both FHA loans and conventional loans.
|FHA Loan Requirements||Conventional Loan Requirements|
|Credit Score||Accepts credit scores as low as 580||Requires a higher credit score of 620|
|Down Payment||Down payment as low as 3.5%||Requires minimum 5%|
|Refinancing||No requirement for reappraisal, credit check, or income verification||Requires a credit check|
|Loan Limits||Median limit is $530,150 for a 4-bedroom home. View Loan Limits »||Median loan limit is $815,650 for a 4-bedroom home.|
|Owner-Occupied||FHA loans are required to be owner-occupied||Conventional loans are not required to be owner-occupied|
|Down Payment Assistance||Down payment assistance programs are available (TDHCA, TSAHC, and SETH)||There are no down payment assistance programs available|
|Mortgage Insurance||There is an upfront mortgage insurance payment required on top of a monthly payment for the life of the loan||No mortgage insurance required so long as the down payment is at least 20% or upon the loan being paid down to 78% of the loan to value.|
|Down Payment as Gift||100% down payment as a gift is allowed||Only a percentage of the down payment as a gift is allowed|
Understanding Your Situation
When a Conventional Loan is Better Than an FHA Loan
If you intend to use a 20% down payment to avoid private mortgage insurance, you will only be able to request for conventional financing due to FHA loans requiring mortgage insurance regardless of the sum of the down payment.
In this situation, a conventional loan will be cheaper than an FHA loan due to the 20% down payment avoiding private mortgage insurance.
When an FHA Loan is Better Than a Conventional Loan
FHA loans are one of the easiest types of loans to qualify for. If you do not have a great credit score or a large down payment, an FHA loan may be a better fit for you.
To satisfy FHA loan requirements, it will be easier for those with credit scores of at least 580. With a credit score of 580, you will only need a down payment of 3.5% which is significantly lower than what is required for conventional home loans.