Conventional vs FHA Loans - What's the Difference?
Considering buying a new home? If you’re a first time home buyer, you might just be learning that there’s a difference between conventional vs FHA loans. Or maybe it’s just been a while and the details are murky. That’s okay. You aren’t expected to know everything about mortgages upfront, but doing a little research will definitely help you prepare to buy your next home.
Who Qualifies for an FHA Home Loan?
It’s easier to qualify for FHA home loans than conventional home loans. That’s because FHA home loans are loans backed by the Federal Housing Administration, which was first started in 1965 at a time when it was hard to qualify for a home loan. In fact, just four in ten homes were owned instead of rented at that time. Below are the general qualifications for FHA home loans.
- Average credit score of 500 to 579 with 10 percent down, or a score of 580 or higher with 3.5 percent down.
- Verifiable employment history for the last two years.
- Verifiable income through pay stubs, federal tax returns and bank statements.
- Loan is used for a primary residence vs. an income property
- Property is appraised by an FHA-approved appraiser and meets property guidelines set by the Urban Housing Development.
- Monthly mortgage payments (front-end debt ratio) doesn’t exceed 31 percent of your gross monthly income.
- Mortgage and all monthly debt payments (back-end debt ratio) shouldn’t exceed 43 percent of your gross monthly income.
- Lenders may allow a ratio up to 50 percent in some cases.
- Buyers who have experienced a bankruptcy must wait up to two years to apply, or three years after a foreclosure, with some exceptions made for extenuating circumstances.
FHA Home Loans vs. Conventional Home Loans
Finding the right home loan depends on your needs as a buyer. There are some benefits to both, but we’ll focus on the benefits of FHA Loans first.
FHA Home Loan vs. Conventional Home Loan: Benefit 1
With FHA home loans, you have more flexibility with how much of your monthly income is being paid towards debts, like credit cards or everyday expenses. This figure is called your debt-to-income ratio. Conventional home loans will sometimes approve loans with a 50 percent debt-to-income ratio, but this is more unlikely.
- Debt-to-income ratio of 50 percent vs. 43 percent for conventional home loans
FHA Home Loan vs. Conventional Home Loan: Benefit 2
If you have lower credit or less of a down payment to make, an FHA might be better for you. FHA home loans require a minimum credit score of 580 with 3.5 percent down, or a credit score between 500-579 with a minimum down payment of 10 percent. With conventional home loans you typically need a credit score over 620. While a lower score may be accepted in some cases, you’d probably have to pay a higher interest rate.
- Credit score 580+ with 3.5% down payment
- Credit score 500-579 with 10% down payment
FHA loans seem like a clear winner if you’re a buyer that has a low down payment or a lower credit score. What are the advantages then of a conventional home loan vs FHA home loans?
Conventional Home Loans vs. FHA Home Loans
If you’ve been saving up on your down payment for a while or working towards building your credit score, then a conventional home loan might be a smarter move for you regardless of whether or not you’re a first-time buyer.
Conventional Home Loan vs FHA Home Loan: Benefit 1
All FHA home loans require something called “mortgage insurance.” This helps protect the lender in case of a default. However, those with heavy down payments or high credit scores may not be too worried about defaulting on their loan. If that’s the case, paying extra every month to ensure that doesn’t happen could seem like an unnecessary expense.
- Lower cost of mortgage insurance for credit scores above 720
- Mortgage insurance automatically cancelled after your equity reaches 78 percent of purchase price
It’s worth noting that you only have to pay mortgage insurance on FHA home loans if you are putting down less than 10 percent. But that insurance never goes away unless you refinance your home later on into a conventional mortgage.
Conventional Home Loan vs FHA Home Loan: Benefit 2
Both conventional home loans and FHA home loans have limits on the amount you can borrow. This limit varies across different areas and changes annually. In 2021, the FHA loan limit is $356,362 for low-cost areas and $822,375 in higher-priced markets. It’s $548,250 for conventional home loans across all of the United States.
- Higher loan limit across the US, regardless of area. (Lower limit in expensive markets)
Working with Different Lenders
There are many different types of lenders to choose from. If you’re considering a new construction home, you could have the opportunity to work with an affiliated lender. Pulte Homes, for example, offers a wide variety of new construction homes across the United States. They also offer their customers the convenience of working with their affiliated lender, Pulte Mortgage. This type of relationship could be valuable if you’re building a new construction home that has different customization options or may require a timeline.
You can also find mortgage lenders by browsing online or using the recommendation of your real estate agent. Not all lenders offer the same loans, so it may take some shopping around.
Contributed to Your Home blog
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