So you’re interested in getting a mortgage but want to find out which loan is better.
FHA loans or Conventional loans?
These loan programs are very different. Choosing the right mortgage programs is critical to make sure you get the best deal on your loan.
In this article we compare FHA and Conventional loans and answer your questions. By the end of this article you will be able to decide which loan type is best for you.
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FHA vs Conventional Loan Comparison Chart
If at least 3 of these statements apply to you then you may be a candidate for a conventional loan.
- Have a 640 Credit score or higher
- Large down payment (5%-20%+)
- Plan on putting down 20% to avoid PMI
- Good income (High DTI ratio)
- Purchasing a higher priced home (Over $271,050 in most areas)
Conventional Loans may be Cheaper
If you are someone who is planning on using a 20% down payment to avoid PMI. You have no choice to go conventional, because FHA loans will require mortgage insurance regardless how much your down payment is. If you have a 20% down payment then a conventional loan will be cheaper than an FHA loan.
Conventional Mortgage Benefits
- Higher loan amounts (up to $424,100)
- No up-front private mortgage insurance (PMI).
- Flexible guidelines on the homes condition
- PMI payments cancel when the LTV reaches 78%
- NO PMI with a downpayment of 20%
- Mortgage insurance is less expensive (0.51% vs 0.85% with FHA)
- 3% downpayment for conventional 97% LTV loan
Conventional Mortgage Disadvantages
- Reserve funds are often required
- 620 credit score requirement (higher than FHA)
- Large downpayment 5%-20% (Unless you qualify for a Conventional 97 loan which requires a 3% down payment)
- Higher interest rates
- More difficult to qualify for than FHA
When FHA Loans are Better than Conventional Loans
An FHA loan is a Government backed home loan program that makes buying a home easier for Americans. The great thing about these loans, is that they’re easier to qualify for. Not everyone has great credit and a large down payment, and with an FHA loan you don’t need to. For people who have low credit scores or funds for a down payment, FHA loans are a great option.
If you have a 500-579 credit score you can qualify for an FHA mortgage with a 10% down payment. Although if you have a credit score in this range it is very difficult to close on a home loan. You should work on increasing your credit scores before applying for a mortgage.
If you have a 580 credit score it is much less difficult to qualify for FHA. You will also need a low down payment of just 3.5%. While conventional loans are cheaper than FHA in the long run, FHA is cheaper up-front because they require a low down payment.
FHA Loan Benefits
- Low downpayment requirement of 3.5%
- The downpayment and closing costs can be given as a gift.
- Easier to get approved for than conventional loans.
- Lower credit scores accepted (580 credit score and higher)
- Lower mortgage interest rates than conventional loans.
- Reserve funds not required.
FHA Loan Disadvantages
- Lower maximum loan limits
- MIP required for the life of the loan if a borrower puts down less than 10%
- Mortgage insurance required even if putting 20% down
- Can only purchase condos that are FHA approved.
- Mortgage insurance monthly cost is higher
Minimum Credit Score requirements for 2017
Your credit score is the biggest factor in getting a mortgage, and getting the best rates. It is best to have a 620 credit score for either a conventional or FHA loan. If you have poor credit and your score is below 620, then an FHA may still be an option.
FHA requires a 500-479 credit score with 10% down. And a 580 or higher score with just a 3.5% down payment. Because of the flexible credit guidelines FHA loans are the better option for people with poor credit.
Comparing credit score requirements
FHA Loan: 500-579 credit score (10% down payment)
FHA Loan: 580+ credit score (3.5% down payment)
Conventional Loan: 620+ credit score (5% – 20% down payment)
Conventional 97: 640+ credit score (3% down payment)
FHA home loans have a major advantage for people who don’t have the money to make a large down payment. A 3.5% downpayment is needed if you have a minimum credit score of 580. If you have a credit score of less than 580, you may qualify by paying a larger downpayment of 10 percent.
- Credit score 500-579 = 10% down payment
- Credit score 580+ = 3.5% down payment
A conventional loan will have a down payment of 5% – 20% depending on the lender, loan type, and credit score of the borrower.
However, there is a conventional 97 loan program that requires just a 3% down payment. This is even lower than FHA loans require.
- Conventional Loan – 5% – 20% down payment
- Conventional 97 Loan – 3% down payment
MIP vs PMI
Mortgage insurance is an annual fee added onto a loan payment to insure the mortgage against foreclosure. Both FHA and Conventional mortgages with less than a 20% down payment require mortgage insurance.
FHA loans act as a type of insurance, they pay the lender in the event a property is foreclosed on. With a Government loan it is referred to as a mortgage insurance premium, or MIP. FHA MIP fee varies but it is typically 0.85% of the loan amount. See FHA MIP Chart
Conventional loans also have mortgage insurance, called private mortgage insurance, or PMI. PMI is only required on conventional loans when the borrower has less than a 20% down payment. PMI on conventional mortgages is usually 0.50% of the loan amount.
How Much Can You Borrow
The Conventional loan limit is $424,100 in most areas of the U.S. However this limit increases to $625,500 in certain high cost areas.
FHA Loan limits are much lower with the limit in most of the U.S. is $271,050. The FHA loan limit also increases in certain high cost areas of the country.
Your debt-to-income ratio is a major determining factor in how much you can borrow. This calculation is the percentage of your monthly income minus monthly obligations. The FHA is much more lenient on maximum debt-to-income ratios.
Typical max DTI :
- FHA – Maximum DTI 45% (Can be as high as 50% in some cases)
- Conventional – Maximum DTI 43% (hard DTI cap)
Conventional Mortgages are cheaper
The upfront costs associated with obtaining an FHA loan is lower with a conventional loan because of the low down payment. However, because PMI is lower on conventional loans and it cancels once the LTV reaches 78%. While FHA Loans are cheaper in the beginning, over the life of the loan conventional loans are the cheapest option.
Both FHA and Conventional loans allow you to refinance your mortgage to get a lower mortgage payment and better interest rate.
If you have an FHA loan you may qualify for an FHA streamline refinance. A streamline refinance works the same as traditional refinancing but requires less paperwork. There is no credit check or income verification. These streamline refinances are done quickly and easily helping borrowers get low rates and reduce their payments.
If you have a conventional loan you can refinance your loan as well. There is a traditional rate and term refinance option for conventional mortgages. This is where the interest rate will be lowered and the term can be extended or shortened. There is another option to refinance your conventional loan. The HARP program allows borrowers with a loan owned by Fannie Mae, or Freddie Mac to refinance their loan regardless of the amount of equity they have.
FHA to Conventional Refinance
If you have an FHA loan and have a LTV ratio of 78% or lower than refinancing into a conventional loan is a good idea. Because conventional loans do not require PMI on mortgages with a 78% LTV ratio you would be able to save money by removing mortgage insurance.
In general, it takes longer to process FHA mortgages. FHA financing requires more time to process due to more bureacracy, and because the property needs to be inspected by a licensed FHA certified appraiser. An appraiser will do a standard appraisal for conventional loans. More problems are found and are required to be repaired before the loan process can move forward with FHA loans.
Are you interested in learning more about the differences between conventional loans vs. FHA loans. To find out what kinds of loans you might qualify for, simply fill out our convenient form.