FHA vs. Conventional Mortgage - What's the Difference?

FHA vs. Conventional Mortgage - What's the Difference?

If you’re purchasing a home, chances are that you and your loan officer are going to discuss FHA and conventional loans. They are two of the most widely-used loan options for homebuyers, but there are distinct differences that are important to note when deciding which to choose. Qualifying for one or the other depends upon a number of factors, such as your credit history and how much cash you are planning to put toward your down payment.

So, let’s walk through a few key highlights, and you’ll have a little more intel when you begin your mortgage journey.

Qualifying for an FHA Loan

FHA (Federal Housing Administration) loans are insured by the federal government. This guarantee makes it possible for FHA-approved lenders to meet the needs of more buyers, even those who may not have a large down payment. 

FHA Down Payment Requirements

You might be asking: what should I save for a down payment? For a homebuyer choosing an FHA loan, the required amount can be as low as 3.5% of the purchase price. That means, if you are buying a house for $200,000, you’ll need to put $7,000 down in order to be eligible for FHA financing, making this loan type a good consideration for first-time buyers.

FHA Credit Score Requirements

FHA loans are also more flexible for someone who doesn’t have a high credit score. With FHA, you may qualify for financing even if you’re still building your credit rating, as long as you are able to put 3.5% down.

FHA Debt-To-Income Ratio Requirements

Another thing to consider when seeking a mortgage is your debt-to-income ratio, or DTI. Your DTI is the percentage of your monthly income that is consumed by debt; including any loans, such as a car payment, minimum credit card payments, child support and other mortgage or rent obligations. To calculate your DTI, take the total of your monthly expenses (not including gas, groceries, or utilities) and divide by your gross monthly income. Viola! That’s your DTI.

Most lenders like to see a DTI of 45% or less when funding a mortgage. However, with an FHA loan, it’s possible to have a debt-to-income ratio up to 50% and still qualify.

FHA Mortgage Insurance Requirements

Another important factor to consider with an FHA loan is mortgage insurance (MI). While homeowners’ insurance protects your dwelling and contents, mortgage insurance secures the loan, and it is required on all FHA loans.

To secure MI coverage, you’ll be charged a premium equal to 1.75% of the loan amount at closing. Additionally, you will pay an annual mortgage insurance premium, usually charged monthly, for the life of the loan.

It is possible to reduce your mortgage insurance term to eleven years, but you will then need to put down 10%. At that point, it often becomes more advantageous to consider a conventional mortgage.

Why You Might Consider a Conventional Loan

In contrast to an FHA loan, conventional loans receive no federal backing and are therefore secured by a private lender, such as your bank. When loans meet certain requirements, they can later be sold to one of two government sponsored enterprises (GSEs) known as Fannie Mae and Freddie Mac. This allows banks to raise more capital and offer more loans to customers, so standards for qualifying for conventional loans are usually higher in order to meet GSE requirements.

Conventional Mortgage Down Payment Requirements

If you choose the conventional route, expect to put down more than the 3.5% required by an FHA loan. This makes conventional loans more desirable for borrowers with strong credit scores and the ability to put down 20% or more, as they can receive a lower interest rate under those circumstances.

Conventional Mortgage Insurance Requirements

Another big difference between FHA and conventional pertains to mortgage insurance requirements. For conventional loans, anything less than 20% down will require private mortgage insurance. This is an annual premium that is usually charged monthly, but unlike an FHA loan, the conventional borrower can request to cancel the insurance once they reach a 20% equity threshold in the property.

Applying for a Mortgage Loan

Since it is easier to qualify for an FHA loan and down payment requirements are lower, it is a good choice for many first-time buyers who have yet to establish a strong credit history or pattern of saving. If you have a higher credit rating, and the ability to fund a more significant down payment, a conventional loan can offer a lower interest rate.

Given the complexities of both loan types, and other possibilities we didn’t cover, it’s important to work with a knowledgeable lender who can help you navigate the pros and cons and determine which mortgage option is best for your individual situation and financial goals.

Once you have chosen a loan product and are ready to move forward, your loan officer will walk you through the application process—whether you are submitting in person, by phone, or even online.

Your loan officer will also help you understand the various documentation you will need and make sure that you have everything in hand to accelerate the time it takes to close on your new home.

When it comes to buying a home, the choice of a loan officer can be one of the most important decisions you’ll make. With an expert by your side, no matter which loan path you choose, someone will be there to provide advice and guidance and help you to understand the full benefits of all of your mortgage options.