Which loan is better – FHA or Conventional? Both are considered low down payment mortgage options, but the right one for you depends on your goals, what type of mortgage you qualify for, and your overall financial situation.
Understanding which type of loan is right for you, and the specific requirements for each, could save you thousands and help you own your dream home quicker than you think!
What is an FHA Loan?
An FHA loan is a government-backed mortgage lending option that guarantees the lender won’t lose any money if the borrower doesn’t make their mortgage payments.
According to the FHA , “The Federal Housing Administration (FHA) is the largest mortgage insurer in the world with an active insurance portfolio of over $1.3 trillion.”
FHA loans are known for their flexibility. Borrowers with low to moderate credit scores or those who may not have a great financial history have the opportunity to get approved for a mortgage loan.
Is it a good idea to get an FHA Loan?
Absolutely, if you have a credit score below 680, or a high debt-to-income ratio (up to 50% DTI) and are financially ready to purchase a home an FHA loan is a great option for you.
There are many pros and cons of FHA Loans.
Advantages of FHA loans
- Low 3.5% down payment with a 580 credit score (10% down with a 500 score)
- Low mortgage rates
- Higher DTI ratios accepted
- Down payments can be a gift
- Choose between 15 or 30 year fixed rate or adjustable rate term
- Down payment assistance programs accepted
- Seller can pay closing costs up to 6%
Disadvantages of FHA loans
- Mortgage insurance is required regardless of down payment size
- The only way to get rid of a FHA loans is to refinance
- Loans are capped base on regional laws
What is a Conventional Loan?
Unlike FHA loans, conventional loans do not offer as much flexibility. So, why do sellers prefer Conventional over FHA? One of the main reasons is because you can avoid PMI (private mortgage insurance) – which offers a significant monthly savings.
Conventional loans often work best for borrowers with higher credit scores because they offer lower interest rates and monthly payments.
Conventional loans have their own advantages and disadvantages compared to FHA loans.
Advantages of a Conventional Loan:
- Less complicated than FHA loans
- Mortgage insurance is not required
- Available for all properties
- More options (7-year term, 10-year term, and more)
- Optional escrow accounts
- Fixed-rate product (locked in interest rate)
Disadvantages of a Conventional Loan:
- Have their own set of requirements and rules for eligibility and repayment
- Higher down payments
- Higher credit score required
What is the Difference between FHA loans and Conventional loans?
The main difference between FHA loans and conventional loans is their requirements. FHA loans are typically easy to qualify for, even if you have a lower credit score. Conventional loans require a strong credit score but they may not require mortgage insurance and allow borrowers to get a loan with as little as 3% down.
FHA loans are a more flexible type of loan and are more common for first time home buyers. Conventional loans are great for borrowers with a strong financial history. To make things easier, we highlighted the main differences between FHA loans and conventional loans.
Minimum down payment
- FHA: Lower down payment requirements (as lo as 3.5%)
- Conventional: Minimum down payment 5%
Credit score qualifications
- FHA: Lower credit scores (as low as 580)
- Conventional: Higher credit scores
- FHA: Interest rates are lower
- Conventional: Interest rates are higher
- FHA: DTI requirements can be up to 55%
- Conventional: DTI requirements can be up to 45% with less than 20% down
- FHA: Upfront mortgage insurance payment and monthly for the life of the loan
- Conventional: No mortgage insurance required if you put down at least a 20% or once the loan is paid down 78% LTV.
- FHA: Max or minimum loan amounts determined by the county
- Conventional: Max loan amount up to $417,000
- FHA: Must be owner occupied (no vacation home or investment properties)
- Conventional: Does not have to be owner occupied
- FHA: Streamline refinancing (no home reappraisal, credit check or income verification)
- Conventional: Refinancing will require a credit check
Which is Better?
Both loans are a great option depending on your financial situation. If you are a first time home buyer you should consider a FHA loan. FHA loans are great for first time home buyers because of the leniency of credit requirements and a low down payment.
Conventional loans are a great option if you have a strong credit score. They allow you to avoid paying PMI by paying 20% upfront. This lowers your mortgage payments each month. You can even get a conventional loan with an extremely low down payment of only 3%.
FHA loans and conventional loans both have their pros and cons. To find out which loan you are best choosing it’s best to work with a trusted loan officer. If you aren’t sure which loan is best for you, Loan Compass can help.