Conventional vs FHA Loans

By Daniel Duffield

For potential homeowners, especially first-time buyers, deciding what loan to choose can make all the difference in securing a mortgage.  This page describes two of the most popular loan types:conventional mortgage loans and FHA mortgage loans; while both options are viable ways to secure the funds necessary to purchase a home, each has its own advantages and disadvantages worth considering, and in turn, each benefits different types of borrowers. To determine which loan best suits your circumstances, take some time to consider the qualities of each and make an educated decision.

The Differences between FHA vs. Conventional 

The differences between an FHA loan and a Conventional loan are many, but the differences in value are subjective:

• If you have low credit score and need down payment assistance, consider an FHA home loan.
• If you’re ready to secure a mortgage and don’t want to pay for private mortgage insurance, seek a conventional home loan.

What is a Conventional Home Loan?

Conventional Loan defined: Mortgage loans that are not guaranteed or insured by the federal government. These loans may follow the guidelines of the Government Sponsored Enterprises (GSE’s) such as Fannie Mae and Freddie Mac, in which case they are also known as “conforming” loans. When conventional loans do not meet GSE terms and conditions, they are considered “non-conforming.”

Conventional mortgage loans have remained a popular financing choice throughout the years. The 30 year fixed rate mortgage is considered the industry standard, while adjustable rate mortgages, jumbo loans, and other mortgage types are also common. Conventional mortgage financing can be used to fund a home purchase or mortgage refinance and are offered by most lenders.

Conventional loans offer borrowers many options, allowing freedom in choosing the length of the loan period, fixed or adjustable interest rates, and the ability to borrow greater amounts of money without the restriction of generic loan amount caps. In addition, potential borrowers who want to avoid purchasing mortgage insurance, should consider conventional mortgage loans.

A disadvantage to conventional financing is that it relies heavily upon credit scoring.  A credit score is a rating given by a credit bureau; this is also known as a Fico Score.  These scores are provided by the 3 credit Bureau's Experian, Trans-Union, and Equifax, and they rank potential home owners credit profiles. For each inquiry, derogatory credit mark, or public record that shows up on your credit report, your scored is lowered even if these items are erroneous. Consequently, people with a low credit score may find it difficult to acquire a conventional home mortgage loan.  Conventional loans require a minimum of a 680 mid-Fico score to acquire Private Mortgage Insurance, aka PMI, which is required on all loans that do not have at least a 20% equity in the home. For home buyers purchasing a home can have a lower Fico score than a 680 on a conventional loan provided they have a minimum 20% down payment.  This can be a disadvantage for those who do not have 20% down payment or 20% equity in their home when they refinance.

FHA Home Loans

FHA Loan defined: FHA Loans are loans that are insured by the Federal Housing Administration (FHA) and allow lenders to offer to consumers less stringent loans to consumers such as: 1) Down Payment Assistance programs 2) lower credit scores and 3) easier income requirements. FHA loans also provide specialty programs for lower income home buyers to allow them to purchase homes that they could not otherwise afford. FHA loans must be provided by an FHA-approved lender.

The Federal Housing Administration (FHA) has provided federal assistance with mortgage loans since its creation in 1934 during the Great Depression. FHA loans are gaining popularity today regardless of household income. An FHA loan may be the right fit for you if you are seeking a mortgage with less-strict qualification requirements than a conventional mortgage loan. In general, if you have a low credit score and/or income challenges then you should consider an FHA home loan. Thus, the Federal Housing Administration (FHA) allows borrowers who have had a few credit challenges.

Additionally, if a borrower has low cash reserves and can’t afford a down payment, an FHA mortgage loan is a great option. For many borrowers, one of the main attractions of an FHA loan is the low minimum down payment required of 3.5%. While this rate only applies to those with a credit score greater than 580 (also determined at the lender’s discretion), this enables many purchase a home without having to raise a large sum of money.  FHA also allows for down payment money in the form of Gifted Funds from a family member, a government entity, or an employer.

FHA vs Conventional

The main advantage of an FHA mortgage loan is the qualification requirements for borrowers which are usually not as strict as those required with conventional mortgage lenders. A borrower with a lower credit score that would not qualify for a conventional home loan can sometimes secure an FHA loan without any issue. However, FHA mortgage loans are also increasingly popular with borrowers with excellent credit, especially since the loan limits have increased in many parts of the country.

See if you Qualify for an FHA Loan

FHA vs. Conventional Loan FAQ

Who should get an FHA Mortgage Loan?

Here are a few questions that you might ask yourself to determine whether or not an FHA loan is your optimal choice:

Do I have a low credit score?

• One of the major advantages of FHA loans is their lenient credit requirements, which enable borrowers with less-than-perfect credit to secure mortgage loans. Even borrowers who have filed for bankruptcy or undergone a foreclosure may still be able to qualify for an FHA loan, provided credit standing has since improved.

What if I cannot afford a large down payment?

FHA loans provide borrowers with a loan option that does not require a significant down payment. If you are unable to afford putting down a large sum for a down payment, you should consider taking out an FHA mortgage loan, since down payments can be as low as 3.5%.

Will an FHA loan cover the cost of my potential home?

• The Federal Housing Administration determines loan limits by relative housing values; there are separate loan limits for every county.  If your prospective residence costs more than the maximum limit for an FHA loan, you should consider an alternative.

Who should get a conventional mortgage?

For borrowers considering a mortgage not insured by the federal government, here are a few questions which you might ask yourself to consider whether a conventional loan would be right for you:

Do I need flexibility?

• While FHA loans do not offer a variety of options when selecting loan terms, conventional loans give borrowers a plethora of options and can consequently be more customized to fit your circumstances. If you would like more freedom as far as loan options go, a conventional loan will provide just that.

How much does my potential home cost?

• Conventional loans limits vary between conforming and non-conforming mortgages. Conforming conventional loans must follow Fannie Mae and Freddie Mac guidelines and thus are limited to $417,000 for single-unit residences. On the other hand, non-conforming loans do not have a loan limit and allow borrowers to secure much larger loan such as a Jumbo loan. Therefore, if the price of the home that you want to purchase exceeds the funds you could secure from an FHA lender or the regional FHA loan limit, you should consider a conventional mortgage.

Can I afford to make a large down payment?

• Conventional loans require a minimum down payment of 3%.  However, making a larger down payment can significantly reduce interest rates on mortgage loan offers, thus benefiting those able to afford this option. In addition, borrowers who make a down payment of 20% or more can circumvent Private Mortgage Insurance, further reducing the loan cost.

Do I qualify?

• Conventional loans have more rigid qualifications than mortgage loans secured by the Federal Housing Administration. In addition to requiring a stable income, conventional loans greatly factor in patterns in credit history when determining whether or not to approve a borrower. As such, borrowers with damaged credit should consider other loan programs which may offer better interest rates to low credit borrowers.
   

Where to Find an Approved Lender Near You

If you are considering taking out an FHA or Conventional loan, it is important to shop around to find the absolute best rates for your loan. Due to the large amounts of money in an FHA or Conventional loan, small adjustments in interest rates can make a significant difference in the total cost of your loan. To find the best possible rates for your future loan, simply fill out our Lender411's Request a Quote.

Contributing Author:

Carlo Sanchez, Security National Mortgage Company

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