FHA Loans Vs. Conventional Loans

So the time has come, and you’re ready to buy a house, but when it boils down to home loan options, which would be the best for you? An FHA loan or a conventional loan? We’ll discuss the difference and the pros and cons of each loan so that by the time we wrap things up, you can decide which home loan is best for you.

What Is a Federal Housing Administration (FHA) Loan?

A Federal Housing Administration (FHA) loan is a home mortgage insured by the government and issued by a bank or a separate lender that the agency will approve. FHA loans typically accept a lower down payment than conventional loans, and applicants may have lower credit scores. Loan borrowers' credit scores for this loan are usually below 600. The FHA loan is tailored to help low- to moderate-income families attain homeownership. And believe it or not, this home loan is the most popular among new homebuyers.

How Does the FHA Loan Work?
If you (the borrower) have a credit score of 580, you can borrow up to 96.5% of the value of a home with an FHA loan which would require a down payment of 3.5%. If your credit score falls between 500 and 579, you can still get an FHA loan if you make at least a 10% down payment.

There are different types of FHA loans available

Home Equity Conversion Mortgage (HECM)
The Home Equity Conversion Mortgage program helps seniors ages 62 and older convert the equity in their homes to cash while retaining the home's title. The homeowner can withdraw the funds in a fixed monthly amount, a line of credit, or a combination of both. Think of this program as a cash-out refinance program.

FHA 203(k) Improvement Loan
This home loan factors the cost of certain repairs and renovations into the amount borrowed. It's great for those willing to buy a fixer-upper and happily restore equity into their home.

FHA Energy Efficient Mortgage
This program is similar to the FHA 203(k) improvement loan program. Still, it’s focused on upgrades that can lower your utility bills, such as new insulation or installing solar or wind energy systems.

Section 245(a) Loan
This program works for borrowers who expect their incomes to increase. The Graduated Payment Mortgage (GPM) starts with lower monthly payments that gradually increase. The Growing-Equity Mortgage (GEM) has scheduled increases in monthly principal payments. Both promise shorter loan terms; sometimes, paying it off quicker is better.

Does Your Home Qualify For an FHA Loan?

If the home you’re inquiring about is your primary living space, then yes, your home is qualified. But remember, if you’re looking to invest in a rental property and aren’t occupying that property, an FHA Loan would not work for you.

This is also a good option if you are looking at the FHA Loan for a townhouse, condo, or other FHA- approved projects.

You will need a property appraisal from an FHA-approved appraiser, and the home must meet specific standards and guidelines for approval. If the home doesn’t meet these standards or the guidelines required and the seller doesn’t agree to the required repairs, you must pay for the repairs at closing.

Are you considering an FHA Loan? Before you do, here are the pros and cons of FHA Loans.

Pros of FHA Loans

• Lower down payment
• Easier lending standards
• Lower interest rates

Cons of FHA Loans

• Mandatory mortgage insurance
• For primary residences only
• Have stricter property standards
• Restrictive loan maximums

Now that you understand the FHA loan better, let’s jump into what a Conventional loan is and how it works.

What Is a Conventional Loan?

A conventional loan is a mortgage loan that a government agency does not support. While some government-backed loans provide unique benefits to homebuyers, conventional loans remain far and away the most common type of mortgage. Conventional loans are available to anyone who can meet the requirements.

How does the Conventional Loan work?
Private mortgage lenders like banks, credit unions, and other financial institutions are typically where conventional loans are backed and serviced.

Conventional loans are separated into conforming and nonconforming loans, depending on whether or not they conform to guidelines set by the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac), the two government-backed mortgage companies that own many mortgages in the U.S.

Information You Should Know About Conventional Loans

Credit score: You can be approved for a conforming conventional loan with a credit score as low as 620. Some lenders may look for a score of 660 or higher.

Debt-to-income ratio: Your debt-to-income ratio (DTI) is a percentage that represents how much of your monthly income goes to pay off debts. You can calculate your DTI by adding up the minimum monthly payments on all your debts and dividing it by your gross monthly income. For most conventional loans, your DTI must be 50% or lower.

Down payment: You can find conventional mortgage loans with a down payment requirement as low as 3%, and some lenders have special programs that offer up to 100% financing. However, if you don't put down 20% or more, the lender typically requires you to pay private mortgage insurance.

Loan amounts: Conforming conventional loans go as high as $647,200 for single-family homes in 2022 ($970,800 if you live in a designated high-cost area). If you require a bigger loan than that, you'll need a jumbo loan.

Loan terms: Conventional loans are typically repaid over a 30-year term, but you could qualify for a 15- or 20-year conventional mortgage loan.

Interest rates: You can get a fixed-rate loan or an adjustable-rate loan. Your interest rate will largely depend on your credit score and overall credit history. The better your credit score, the less you'll pay in interest over the life of the loan.

To Sum Up This Section, Here Are the Pros and Cons of Conventional Loans

Pros of Conventional Loans
Mortgage insurance depends on equity
Not limited to primary residences
Have more liberal property standards
Opportunity to borrow more

Cons of Conventional Loans

• Stricter lending requirements
• Requires a higher credit score to qualify
• Requires a lower debt-to-income (DTI) ratio
• Require private mortgage insurance when the down payment is less than 20%, and the insurance may be canceled

What If I’m a Veteran or the Spouse of a Veteran?

If you’re in the military or are a veteran, a loan backed by the VA may be the way to go. VA loans usually require no down payment. And if you live in a suburban or rural area, a USDA loan could be a smart option, too. There may also be more flexibility with credit score requirements if you’re considering using VA benefits such as a VA loan.

The U.S. Department of Veterans Affairs backs VA loans. These loans are available to qualified members of the armed services, their spouses, and other beneficiaries. VA loans don’t require a down payment and typically don’t charge mortgage insurance.

We think you’re ready to take the next step!

Now that we have discussed your options and broken them down to the specifics, which loan will be right for you?

Whether you choose the FHA loan, a conventional loan, or a veteran loan, now you know which loan would best suit your needs, and you’re most likely in a position where you know which loan you’ll qualify for. Need some help or guidance with no strings attached? Fetcharate has you covered!