What is the difference between FHA and conventional loans? In fact, there are several disparities that make FHA loans and conventional loans unique from one another. Taking the time to discover these differences and how they impact borrowers can help you choose the best home loan for your specific needs.
Discovering the Difference Between FHA and Conventional Loans
A major clue to the primary difference between FHA and conventional loans can be found in their names. FHA loans are government-backed loans insured by the Federal Housing Authority (FHA), which is part of the U.S. Department of Housing and Urban Development. Conventional loans are mortgages offered by lenders without any government guarantees.
While both FHA and conventional loans are made and serviced by private lenders, the guarantee that accompanies an FHA loan reduces the risk to lenders so that they can make loans available to borrowers who might not qualify for a conventional loan.
When considering these two types of loans, what differences will borrowers notice?
The Qualifications for Approval
As SmartAsset notes, FHA loans aim to make it simple to become a homeowner, so it should come as no surprise that it is generally easier to get approved for an FHA loan than a conventional loan. What does this mean for borrowers? While you may be able to secure an FHA loan with a credit score of 500, you’ll likely need a score of 620 or more to snag a conventional loan.
In addition, borrowers who do not qualify for an FHA loan on their own can have a blood relative who won’t be living in the home but is willing to help them out serve as a non-occupying co-borrower for the purposes of securing the loan. This is a way for borrowers with a weak or tarnished credit history to improve their odds of getting approved. It isn’t an option for conventional loans.
The Down Payment
How do the down payment requirements for an FHA loan compare to those for a conventional loan? Again, the FHA loan is designed to make it easy for an aspiring buyer to succeed. As U.S. News & World Report explains, you can make a down payment of just 3.5% with a credit score of at least 580. If your credit score is between 500 and 580, then you’ll need to come up with a down payment of at least 10%. However, when it comes to down payment requirements, conventional loans aren’t that different. If you search around, you can find conventional loans with down payment requirements as low as 3%, but down payments between 5% and 20% are more common.
The Mortgage Insurance
While mortgage insurance is rarely at the top of a potential borrower’s list of concerns, it can raise your monthly payment and add a substantial amount to the total cost of your loan, so it should definitely be a consideration.
As NerdWallet indicates, every FHA loan requires mortgage insurance. Borrowers must pay both an upfront-fee and a monthly premium. The premium is the same whether your credit score is high or low, but if you make a down payment of less than 10%, then you’ll have to pay mortgage insurance for as long as you have the loan. Refinancing is the only way to put a halt to it.
In contrast, conventional loans don’t automatically require mortgage insurance. Borrowers who make down payments of 20% or more won’t need it. In addition, most conventional loans allow you to stop paying for mortgage insurance when your equity is equal to 78% of the home’s price tag.
The Purchasing Possibilities
One of the biggest differences between FHA and conventional loans is flexibility. According to U.S. News & World Report, you’ll find your options for properties are far more restricted if you opt for an FHA loan.
For starters, FHA loans can only be used to buy a primary residence. You must plan to live in the home you buy. In addition, the FHA has minimum property requirements that any home purchased with this form of financing must meet. Appraisals are more stringent, and some sellers are reluctant to deal with the red tape involved, which can place would-be buyers at a competitive disadvantage.
Conventional loans are more flexible. They can be used to purchase a primary residence, vacation home, or investment property, and they generally allow more wiggle room during inspections and processing.
Could there be another loan program that is an even better fit for your needs? To find out, reach out to PrimeLending Twin Cities. We’ll listen to your goals, help you understand your options, and guide you through the entire loan process. We offer a wide range of loan products, including FHA loans and conventional loans, so it’s easy to find the right loan for your needs. Contact us today to arrange an appointment.