When people want to buy a house, they often need to borrow money. Two popular ways to do so are with a Federal Housing Authority (FHA) loan, which is like a helping hand from the government, or a conventional loan, which comes from a private lender, like a bank.
The better option for you depends on your credit score, how much money you have for a down payment, and your long-term financial goals.
What are FHA loans?
These loans are supported by the FHA, which makes lenders more willing to approve applicants who don’t meet standard loan requirements. It’s typically easier to qualify — you can often pay as little as 3.5% upfront if your credit score is not lower than 580.
The key features of FHA loans include:
- Lower credit score requirements: You may be approved even if you have a lower credit score than 580 or a limited credit history.
- Mortgage insurance: You’ll need to pay an upfront mortgage insurance premium (UFMIP) and monthly mortgage insurance premiums (MIPs).
- Flexible debt-to-income (DTI) ratio: FHA loans allow higher debt-to-income ratios, which means buyers can qualify even if their monthly debts take up a larger portion of their income.
- FHA appraisals: Homes must meet safety and livability standards as part of the appraisal process.
The FHA sets loan limits each year. These limits establish the maximum amount you can borrow and vary by county. Be sure to check the limit for your specific county before applying.
What are conventional loans?
Backed by private lenders, conventional loans typically follow standard rules, so they’re also called conforming loans. The rules they follow are set by agencies such as Fannie Mae, Freddie Mac, and the Federal Housing Finance Agency (FHFA).
Many borrowers prefer conventional loans because they offer the following features:
- No UFMIP: Paying an upfront mortgage insurance is not required.
- Option to cancel mortgage insurance: When your loan-to-value (LTV) drops to 80%, you’re eligible to remove private mortgage insurance from your payments.
- Higher loan limits: Conventional loan limits are typically higher than FHA limits.
- Favorable interest rates: Those with good credit scores can often get better interest rates on conventional loans.
What are the common requirements for conventional loans?
To get a regular loan, your credit score usually needs to be around 620, but some lenders might have different rules. For instance, Fannie Mae doesn’t have minimum credit score requirements for conventional loans. If you’re buying a home for the first time, you might only need to put down 3%–5% of the cost. Lenders also check your DTI ratio, which should typically be under 43%.
FHA vs. conventional loans at a glance
Let’s compare the key differences between FHA and conventional loans:
| Feature | FHA loans | Conventional loans |
|---|---|---|
| Backing | Federal Housing Administration | Private lenders regulated by the FHFA |
| Credit score minimum | 580 | Varies |
| Down payment | As low as 3.5% | Typically 3%–5% |
| Mortgage insurance | Required for all FHA loans | Required only if down payment < 20% |
| Possibility of cancelling mortgage insurance | Only possible if 10% down payment has been made and 11 years of payments have been completed | Possible, at 80% LTV |
| Loan limits | Lower limits | Usually higher limits |
| Interest rates | Often lower, but with insurance premiums | Varies with credit; best rates possible for higher credit scores |
| Appraisal requirements | Stricter property standards | More flexible appraisals |
How does your DTI ratio affect your loan approval?
Your DTI ratio calculates the percentage of your monthly income that goes toward paying debts such as credit card balances, car loans, and rent.
A lower DTI is good for lenders, as it shows that you can pay off your loan with the money you earn every month. It also positions you for more favorable mortgage rates and dramatically simplifies your loan approval journey.
Typically, FHA loans let your DTI be up to 50%, while conventional loans limit it to 43%.
Which loan type costs less overall?
FHA loans might seem attractive with lower upfront interest rates, but their mortgage insurance costs can accumulate significantly over time. Borrowers typically face an upfront MIP, usually 1.75% of the loan amount, and ongoing monthly MIPs that continue until the loan is paid.
For conventional mortgages, PMI is typically mandatory if your initial down payment is less than 20%. The good news is you can usually discontinue these payments once you’ve built up 20% equity in your home.
If you have good credit and plan to stay in your home for many years, a conventional mortgage may save you more money in the long run.
How do mortgage rates differ between FHA and conventional loans?
Your credit score, the amount you borrow, and current interest rates all influence your mortgage rate. However, note that:
- FHA loan interest rates are typically lower because they’re government-backed, but you’ll still pay insurance premiums.
- Conventional loan interest rates may start higher for borrowers with lower credit scores, but those with higher credit scores often qualify for better terms.
Comparing mortgage lenders and getting prequalified can help you see which loan type gives you the lowest total cost.
How is the appraisal process?
FHA appraisals are more thorough because they check if the home is safe, secure, and livable. Meanwhile, conventional appraisals focus on market value and are more flexible about the property’s condition. If you’re looking at a renovation project or an investment property, a conventional loan might be a better option because the appraisal process is less strict.
Choosing between FHA and conventional loans
Deciding between an FHA loan and a conventional loan really comes down to your personal finances.
- FHA loans: Perfect for first-time homebuyers, people with lower credit scores, or those who don’t have enough savings for a down payment
- Conventional loans: Best for borrowers with stable income and good credit who want to avoid extra costs (e.g., MIPs)
Like FHA loans, government loans usually approve applications for primary homes, or the house you will live in. Conventional mortgages, on the other hand, are more flexible and can be used for second homes and investment properties.
However, keep in mind that conventional mortgages are subject to limits set by the FHFA. If you need an amount larger than the limit, you’ll have to apply for a jumbo loan, which often has higher interest rates and stricter requirements.
Make the right choice with expert help from Directions Home Loan
Directions Home Loan is here to simplify your mortgage process. Our team of experienced lenders can help you compare FHA and conventional loans, review your loan limits, and secure the best possible mortgage rates for your situation.
Start your prequalification with Directions Home Loan and discover the best mortgage option for your goals. Contact us today.
