Conventional and FHA loans are the two most popular loan options you will see when you get ready to purchase a house or refinance your mortgage. Let’s take a look at the two mortgage programs and see their features along with key differences that set them apart.
- Conventional loans have a minimum credit score requirement of 620
- FHA loans have a minimum credit score requirement of 500
- People with good credit and lower levels of debt tend to qualify for conventional mortgages
- FHA loans are backed by the government while conventional loans are not
- FHA loans also require borrowers to get mortgage insurance as they tend to be more risky for lenders
What is a Conventional Loan?
Conventional loans are the most common mortgages used by people to purchase homes. They generally require borrowers to have higher credit scores and are insured by private lenders and subsequently sold to GSE’s like Fannie Mae and Freddie Mac. The minimum credit score required to qualify for a conventional mortgage is 620. You will also need to have a lower debt-to-income ratio (DTI) to qualify.
Conventional loans have different mortgage types such as a fixed rate or an adjustable-rate mortgage. They also have different loan terms ranging from 10 – 30 years.
Conventional Loan Qualification Requirements
The qualifications for a conventional mortgage tend to be much stricter than those for an FHA loan. Let’s take a look at the qualification requirements for a conventional mortgage below:
- Minimum credit score of 620
- Minimum down payment of 3%, although it can be higher depending on the conventional mortgage type
- Debt-to-income(DTI) must be below 45%
- Property appraisal must be done to verify the value and condition of the property
- Property limit varies by county, the limit in 2021 was $548,250
What is an FHA Loan?
An FHA loan has less stringent requirements for borrowers and it’s a great option for first-time homebuyers. FHA loans are also backed and insured by the Federal Housing Administration (FHA). People with low-to-moderate income and a lack of credit history can use an FHA loan to purchase or refinance a home.
Recommended Reading: Multiple FHA Loans – How Many FHA Loans Can You Have?
Since FHA loans are federally insured, lenders can offer favorable terms for borrowers such as lower interest rates, lower down payment amounts, and lower credit scores. For most borrowers qualifying for an FHA loan is much easier than qualifying for a conventional mortgage.
FHA Loan Qualification Requirements
The qualifications requirements for an FHA loan are less stringent than those for a conventional loan. Below are the standard FHA loan requirements:
- FICO score of at least 580, 3.5% down payment
- FICO score between 500 and 579, 10% down payment
- A debt-to-income ratio of less than 43%
- MIP (mortgage insurance premium) is required
- The home must be the borrower’s primary residence
- Must have proof of employment
It’s also worth noting that there are different FHA loan types such as an FHA 203(k) and an FHA 203(b) which have their own requirements and limitations. FHA loans are a great option for first-time homebuyers who may not have saved enough money for a down payment, have poor credit and lower-income levels.
Differences Between a Conventional Loan and an FHA Loan?
The biggest difference between a conventional mortgage and an FHA mortgage is that an FHA loan allows lower credit scores while most conventional mortgages do not. FHA loans are also insured by the Federal Housing Administration while conventional mortgages are not.
Another big distinction between a conventional loan and an FHA loan is the mortgage insurance requirements. If you put down less than 20% on a conventional loan, you’ll be able to cancel the PMI once your loan crosses the 20% equity threshold. However, with an FHA loan, your mortgage insurance premium is paid upfront into the mortgage so you don’t have the option of removing your mortgage insurance.
The only way to get rid of the PMI for an FHA loan is if you refinance into a conventional loan once you have 20% equity in the house. Although you have to pay PMI for an FHA loan, they are still a great option for borrowers who don’t qualify for a conventional mortgage.
Important Note: A common difference between an FHA loan and a conventional loan is that the FHA loan time line to close can often times be longer than conventional loans.
What is the Advantage of an FHA loan over a Conventional Loan?
This simply depends on your financial and credit information. The two loans differ greatly when it comes to their qualification requirements and you should know how each one works before you decide to get a mortgage. Below are some of the advantages of FHA loans.
Advantages of FHA loans
- Lower-income level requirements to qualify
- Lower minimum credit score requirements
- Great for first time home buyers who don’t have a ton of credit history
- Lower down payment requirements
- Different FHA loans can give you the ability to finance the cost of the home along with repairs, FHA 203(k)
It’s worth noting that conventional mortgages also have their own advantages over FHA loans. One of the biggest differentiating factors is the fact that your PMI can drop off after you have 20% equity in your home. This isn’t the case with FHA loans since the PMI is rolled into the cost of the loan.
What is the Downside of an FHA loan
Just because FHA loans are easy to qualify for doesn’t mean that they don’t come with their own disadvantages. If you’re considering using an FHA loan, below are some of the disadvantages that come with the loan. A common question by people getting an FHA loan over a conventional loan is how often are FHA loans denied in underwriting? The answer might surprise you.
Disadvantages of FHA Loans
- They require mortgage insurance premiums upfront and annually
- FHA loans typically have higher interest rates than conventional mortgages
- Can’t be used for investment purposes or second homes, the home must be your primary residence
- The property has to pass safety standards established by the Department of Housing and Urban Development (HUD)
These may not necessarily be downsides for you as a borrower. But they are disadvantages if you consider the overall cost and limitations of the loan itself. This however depends all on your needs as a borrower.
Before you to decide to get a mortgage it’s important to first take a look at your financial situation and determine what you intend to use the mortgage for. From there you should review each loan program and its related terms and requirements to make an informed decision about the mortgage you plan on taking out.