There are several types of home loans, but which is right for you? FHA loans and conventional mortgages are 2 common home loan options. Here’s everything you need to know about choosing between an FHA or conventional mortgage.
What Is an FHA Mortgage?
The Federal Housing Administration (FHA) insures FHA mortgages. That means that if a borrower defaults (stops paying) on a home loan, the FHA will help cover the costs for the lender.
FHA loans have low down payment requirements. This makes them a good choice if you’re a first-time home buyer. Depending on your credit score, you could make a down payment as low as 3.5%.
These loans were started in the late 1930s to help stabilize the mortgage market after the Great Depression. Before the FHA was established, home loans had short pay-off terms of 5 years. The loans also weren’t paid off at the end of the term, so you had to make a large payment or hope your lender would renegotiate with you.
To fix this, the FHA introduced 20-year amortizing mortgages. That means that end of the mortgage, the loan is paid off and you own the home outright.
Today the FHA insures home loans offered through approved private lenders. The flexible requirements mean a wider range of borrowers can own a home.
FHA Loan Requirements
What are the requirements for an FHA loan? Let’s take a look.
Minimum Down Payment
Depending on your credit score, you could make a down payment of as little as 3.5%.
Credit Score
The FHA allows borrowers to have credit scores as low as 500. If you have a credit score of 500 to 579, you must make a down payment of at least 10%. If you have a credit score of 580 or higher, you can make a down payment of 3.5%. Keep in mind that lenders may have a higher minimum credit score requirement.
Owner Occupancy
In most cases, the borrower must live in the home as a primary residence. It can’t be a 2nd home or an investment property.
Debt-to-Income Ratio
In general, your potential loan payment can’t be more than 31% of your gross (pre-tax) monthly income. Your total monthly debt payments, including your potential home loan, can’t be more than 43% of your gross monthly income. Your lender may allow a higher percentage if you have compensating factors like a significant amount of savings.
Loan Limits
There’s a limit to how much you can borrow with an FHA loan. The loan limits vary depending on where you live. In most areas, the loan limit is $331,760. Those living in areas with higher home prices may have limits up to $765,600. Alaska, Hawaii, Guam and the Virgin Islands have a loan limit of $1,148,400. You can find your loan limit on the Department of Housing and Urban Development (HUD) website.
FHA Loan Pros and Cons
Is an FHA loan right for you? Here are some pros and cons to consider.
Pros
- Flexibility. You can use an FHA loan to buy several types of property, including single-family homes, townhouses, condos and manufactured homes.
- Variety of loan terms. The FHA allows a variety of home loan terms. The maximum loan term is 30 years, and loans with a fixed rate and loans with an adjustable rate. A home loan with a fixed rate has an interest rate that never changes. An adjustable-rate loan has an interest rate that the lender can change.
- Easy refinancing. FHA loans offer a streamlined refinancing option, which means you can refinance with minimal paperwork.
Cons
- Mortgage insurance. You’re required to pay mortgage insurance if you take out an FHA home loan. There’s an upfront mortgage premium, which is 2.75% of the amount of your mortgage. It can be rolled into your home loan. There’s also an annual mortgage premium that you pay as part of your mortgage payment. The amount varies depending on how much you put down on your home.
- Loan limits. There’s no flexibility when it comes to the loan limits. If you fall in love with a home that exceeds those limits, you’ll need to use a different type of home loan.
The Best FHA Mortgage Lenders
Which FHA lenders are the best? Here are Benzinga’s picks.
What Is a Conventional Mortgage?
Conventional mortgages aren’t insured by a government agency, which sets them apart from FHA loans. They fall into 2 categories: conforming and non-conforming.
A conforming conventional mortgage is a mortgage that can be sold to Freddie Mac or Fannie Mae. These are government-sponsored entities, which means they are private companies that were started by Congress to help stabilize the mortgage market. Selling mortgages to Freddie Mac or Fannie Mae allows lenders to free up funds to make new loans. The original lender may still manage your loan payments.
Conforming mortgages have to meet specific requirements to be sold to Fannie Mae and Freddie Mac. Conventional mortgages that don’t meet these requirements are non-conforming. Non-conforming loans are less standardized, so it’s important to carefully review the loan terms if you’re considering a non-conforming loan.
Conventional Loan Requirements
Here are the requirements for a conventional loan.
Credit Score
The minimum credit score varies by lender. In general, you’ll need a score of at least 620.
Debt-to-Income Ratio
Lenders typically prefer that your monthly debt payments are 43% or less of your monthly gross income. If you have compensating factors like significant savings, you may be able to have debt payments of up to 50%.
Down Payments
With conventional loans, down payments vary depending on the terms of the mortgage and your situation as a borrower. A first-time home buyer could make a down payment as low as 3%. If you’ve bought a home before, you may be able to make a down payment of 5%. If you’re buying a 2nd home, you’ll need to make a down payment of 10% or more.
Private Mortgage Insurance (PMI)
PMI is insurance that assists the lender if a borrower stops making mortgage payments. If you make a down payment of less than 20%, you’ll most likely be required to pay for PMI. The cost of PMI varies depending on how much you put down, the size of your mortgage and your credit score. PMI is typically paid monthly, but some borrowers pay it upfront. You don’t have to pay for PMI forever, though. Once you’ve paid 20% of your loan, you can ask your lender to remove your PMI.
Conventional Loan Pros and Cons
Considering a conventional mortgage? Here are a few benefits and drawbacks.
Pros
- Flexibility. You can use a conventional mortgage to buy a 2nd home or an investment property. You can also use non-conforming loans to buy harder-to-finance properties like homes with more than 10 acres of land.
- Higher loan limits than FHA loans. While conforming loans do have limits, they’re higher than FHA loan limits. In most areas, it’s $510,400. In areas with higher home prices, it’s up to $765,600. You can find a map of conforming loan limits on the Federal Housing Finance Agency website. Non-conforming conventional loans don’t have limits.
Cons
- PMI. With PMI, you’re paying for something that benefits the lender, and not you. It also increases your monthly loan costs. It does go away over time, though.
- Stricter requirements. Conventional loans typically require a higher credit score than FHA loans. That said, some non-conforming loans are designed for borrowers who don’t qualify for conforming or FHA loans. For example, some lenders offer bank statement qualifier mortgages. These loans help self-employed borrowers qualify for a mortgage based on their bank deposits rather than their tax returns, which may show a lower income.
The Best Conventional Mortgage Lenders
Which conventional lender is right for you? Here are Benzinga’s top picks.
Key Factors to Consider
The right mortgage for you depends on your situation and the home you’re buying. If you’re buying a home that exceeds FHA loan limits, you’ll need to opt for another type of mortgage. Here are a few factors to consider:
Mortgage Rates
Talk to lenders and find out what loans you qualify for and their mortgage rates. Keep any fees or discounts in mind as you compare rates, and be sure you’re comparing the same type of mortgage. For example, you may want to get quotes from a few lenders for a 30-year fixed-rate mortgage. That way, it’s easier to compare your options.
Credit score
If your credit score is less than stellar, you may want to opt for an FHA loan.
Lender services
If you have a lender you prefer, what types of loan does it offer? If you’re shopping for a lender, consider whether they offer service options that make sense for you. For example, if you prefer handling everything online, you’ll want to work with an online mortgage lender or a traditional lender with a strong digital presence. If you want to work with someone in person, choose a lender with physical locations near you.
Special circumstances
If you’re self-employed or buying an unusual property, a non-conforming conventional loan may be a better fit. Just be sure to review the terms carefully and ask questions if anything isn’t clear.
Take the time to get quotes from at least 2 or 3 lenders. That gives you the best chances of finding a competitive rate and a lender that meets your needs.
Which Mortgage Is Right for You?
When comparing FHA loans and conventional mortgages, it is important to consider your individual circumstances and financial goals. FHA loans may be a better option for first-time homebuyers or those with lower credit scores, as they offer more lenient qualifications and lower down payment requirements. On the other hand, conventional mortgages may be more suitable for borrowers with higher credit scores and a larger down payment, as they often offer lower interest rates and the potential to avoid mortgage insurance altogether. It is advisable to consult with a mortgage professional to determine which type of loan is the best fit for your specific needs.
Frequently Asked Questions
Which loan between FHA and conventional mortgage is better for first-time homebuyers?
FHA loans are often a popular choice for first-time homebuyers due to their lower credit score requirements and lower down payment options compared to conventional mortgages. However, it’s essential to consider other factors such as long-term goals and financial stability before making a decision.
How is mortgage insurance handled in FHA loans and conventional mortgages?
FHA loans require an upfront mortgage insurance premium (MIP) and an annual MIP that is typically added to the monthly mortgage payment. Conventional mortgages may require private mortgage insurance (PMI) for borrowers who put less than 20% down. PMI can be canceled once the loan-to-value ratio reaches a certain threshold.
Can I refinance an FHA loan into a conventional mortgage?
Yes, it is possible to refinance an FHA loan into a conventional mortgage, provided you meet the lender’s requirements and have sufficient equity in your home.
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