Conventional loans may be the most popular among homebuyers, but not everyone can qualify for them.
If you’re a first-time homebuyer or have less-than-perfect credit, you may be wondering if a Federal Housing Administration (FHA) mortgage loan is right for you.
Let’s look at what you need to know about FHA loans before you apply.
What is an FHA loan?
An FHA loan is a home loan insured by the federal government and run by the Federal Housing Administration.
The program is designed to help first-time homebuyers and people with limited incomes qualify for mortgages.
FHA loans are popular because they’re relatively easy to qualify for. If you have a credit score of 550 or higher, you can qualify for a mortgage with as little as 3.5% down.
They’re also more flexible when it comes to credit scores. You can have a bankruptcy or foreclosure in your history and still qualify for an FHA loan.
What is a conventional loan?
A conventional loan is a mortgage that the government does not back. These loans are available through private lenders and are not subject to the same strict guidelines as FHA loans.
Conventional loans are a good option if you have good credit and can afford a down payment of at least 5%. These loans also don’t require mortgage insurance unless your down payment is less than 20%.
The downside of conventional loans is that they typically have higher interest rates than government-backed loans like FHA loans.
Since they’re not backed by the government, lenders will likely have higher qualification standards to ensure they get their loans paid back.
Differences between FHA vs. conventional loans
While both loans can be beneficial for borrowers with limited incomes, there are some key differences:
- The government backs FHA loans, so if you default on the loan, the government will pay the lender.
- The government does not back conventional loans, so if you default, the lender will not get paid.
- FHA loans have more lenient credit requirements, so if you have bad credit, you may still be able to qualify.
- Conventional loans typically have higher interest rates than FHA loans.
- FHA loans require mortgage insurance, paid both upfront and annually.
When do FHA loans make sense?
An FHA loan may be a good option if you’re a first-time homebuyer or have less-than-perfect credit.
FHA loans are usually easier to qualify for than conventional ones and often offer lower interest rates.
When do conventional loans make sense?
A conventional loan may be a good option if you have good credit and can afford a down payment of at least 5%. You’ll avoid mortgage insurance with a conventional down payment of 20%, but you’ll likely face higher interest rates.
Conventional loans also can be used to purchase rental or vacation properties in addition to primary residences and can allow you to buy a more expensive home.
Requirements for FHA loans
FHA loans are more flexible regarding credit scores but can be more strict in other areas.
Requirements for FHA loans include:
- Credit score 500-579 with 10% down
- Credit score 580 and up with 3.5% down
- Debt-to-income (DTI) ratio up to 43%
- Must pay MIP
- Property must be the primary residence
- Property must meet FHA requirements for safety and security
Requirements for conventional loans
Conventional loans have more strict documentation requirements in exchange for more loan options.
Requirements for conventional loans include:
- Credit score of 620 or higher
- Maximum debt to income of 45%
- Down payment as low as 3%, but if you put down 20%, you’ll eliminate private mortgage insurance
- Property can be primary residence, second home, or rental home.
- Home must be safe, sound, and secure
While lenders sometimes allow credit scores as low as 620, conventional loan interest rates will be better for those with a higher credit score.
Do sellers prefer an FHA or conventional loan?
Since an FHA appraisal is required with an FHA loan, some sellers prefer a conventional loan.
During this part of the process, sellers may need to address specific issues found in this appraisal before they can close the sale. An FHA appraisal is a bit more strict than a typical home inspection.
Typically, since sellers want a quick sale, they’ll pick the easier situation for them if they receive multiple offers. That’s not to say that they’ll never accept an FHA mortgage, but understand that it may be a deciding factor for them.
Conversely, if the seller is willing to repair the property, an FHA loan may be a good option for a buyer. This is because FHA loans allow the seller to contribute up to 6% of the sale price toward repairs.
It’s important to compare your options and speak to a reputable mortgage lender before you make a decision.
How do I know which loan is right for me?
The answer to this question depends on your situation.
If you have good credit and can afford a down payment, a conventional loan may be the better option. If you have bad credit or can’t afford a down payment, an FHA loan may be the best option.
The bottom line is that it’s a personal decision that requires thought that factors in all of your circumstances.
Be sure to speak with a mortgage lender to find out what type of loan would be best for you.
Photo by Kindel Media
