FHA vs. Conventional Loan

FHA vs. Conventional Loan: Which One Is Right For You?

FHA vs. Conventional Loan, which loan is right for you? We’ll dive in and show you how each of these loan programs works and by the end you’ll know which loan program will best meet your needs.

What is an FHA Loan

An FHA Loan is a loan that is insured by the Federal Housing Administration. The FHA is part of The Department of Housing and Urban Development.  FHA Loans were created to allow low to moderate income families the ability to purchase a home. 

FHA is known for it’s flexibility when it comes to credit requirements, down payments and it’s low interest rates. 

What is a Conventional Loan

Conventional loans are loans that are provided by lending institutions such as banks, credit unions, and mortgage banks. These loans aren’t insured by any government agency. 

Since these loans aren’t backed by the government, they often require higher credit scores, larger down payments, and private mortgage insurance to qualify.  In many cases you’ll also need a lower debt-to-income ratio to be approved as well. 

Conventional loans often have to “conform” to standards set by Freddie Mac and Fannie Mae.  This is why they are often called conforming loans.  

Freddie Mac and Fannie are now government backed agencies that are responsible for purchasing these mortgages from lenders and selling them as mortgage backed securities. 

FHA vs. Conventional Loan Credit Requriements

FHA Loan Credit Requirements

FHA loans have very flexible credit requirements, and are one of the easiest mortgage loans to qualify for. 

When it comes to credit scores, FHA allows for credit scores as low as 500 but you’ll get the best terms if you have at least a 580 or higher. 

FHA also offers flexibility if you’ve had past credit issues as well. 

FHA allows you to still qualifying for a mortgage even if you’ve have: 

  • Collection Accounts
  • Charged-Off Accounts
  • Late Payments
  • Bankruptcy

However, if you have any type of government collection or judgements those will need to be paid or settled before getting an FHA Loan. 

FHA also provides flexibility with Student loans that are in income based repayment plans or deferment. 

Conventional Loan Credit Requirements 

Conventional loans are typically much more strict when it comes to credit requirements.  The minimum credit score accepted by most lenders is 620.  

However it’s often hard to get approved for a conventional loan even with a 620 unless you have a large down payment.  When working with clients we advise them they’ll need a 680 or higher for a conventional loan to be the better option over FHA. 

Conventional loans are also less forgiving when it comes to past credit issues as well.  If you have non-medical collection accounts you’ll need to pay them off before you can proceed with a conventional loan. 

Charged-Off accounts, late payments, and other credit issues will also make it harder if not impossible to qualify for a conventional loan. 

If however you have high credit scores and good credit history you’ll find conventional loans will often be cheaper. 

FHA vs. Conventional Loan Down Payments

Many people believe you need 20% down in order to purchase a home, especially when it comes to a conventional loan. This is not the case as both FHA and Conventional loans offer low down payment programs. 

FHA Down Payments

FHA has two different types of down payment requirements and the amount you’ll need to pay is determined by your credit score. 

580 or higher: If your score is 580 or higher you’ll only need to put down 3.5% in order to qualify for FHA Loans. 

500-579: If you have a credit score between 500-579, you’ll need to put 10% down in order to qualify for an FHA loan. This larger down payment is a result of the higher risk you pose to the lender as a result of past or present credit issues. 

Conventional Loan Down Payment 

Conventional loans also have a few different down payment requirements depending on your loan program or purchasing situation. 

First-Time Homebuyers

If you are a first-time homebuyer, you’ll only need 3% down in order to qualify for a conventional loan. 

A first-time homebuyer is defined as someone who has not purchased or owned a home in the last 3 years.  So if you’ve never owned a home or haven’t owned one in the last 3 years you can qualify as a first-time homebuyer. 

Repeat Homebuyers

If this isn’t your first time buying a home and/or you’ve owned a home in the last 3 years you will be considered a repeat home buyer. Repeat homebuyers will need at least 5% down in order to purchase a home using a conventional loan. 

Home Ready & Home Possible

If you qualify either Home Possible or Home Ready, you’ll only need 3% down in order to purchase a home. 

These two programs are designed for low to moderate income families. You’ll need to earn less than the median income of your area. 

You can see the income limits for Home Possible here and Home Ready here

Conventional vs. FHA Loan Limits 

Another difference in Conventional and FHA loans is the maximum loan amount you can receive. Conventional loans have higher income limits than FHA.  

A loan limit is the maximum amount you can borrow to purchase a home, and it’s usually determined by whether you live in a low-cost or high-cost area. 

FHA Loan Limits

As of 2022, the FHA loan limits are as follows: 

One Unit: $420,680       

Two Unit: $538,650

Three Unit: $651,050

Four Unit: $809,150

If you live in a high cost area the limits are: 

One Unit: $970,800

Two Unit: $1,243,050

Three Unit: $,1502,475

Four Unit: $1,867,275

If you’re not sure if you’re in a high or lost cost area, one of the easiest ways to tell is the home prices of most homes in your area. In smaller cities and more rural areas homes will be cheaper yet in larger cities on the east and west coast, it’s not uncommon for a 1500 square foot home to cost $1,000,000. 

Another way you can discover what the loan limit is in your area is to view it here on HUD’s website

Conventional Loan Limits 

The conventional or conforming loan limits are set by the Federal Housing and Finance Agency.  

For 2022, the conventional loan limits are:

Low-Cost Areas

One Unit: $647,200

Two Unit: $828,700

Three Unit: $ 1,001,650

Four Unit: $1,244,850

Medium-Cost Areas: 

One Unit: $647,201-$970,799

Two Unit: $828,701- $1,243,049

Three Unit: $ 1,001,651- $1,502,474

Four Unit: $1,244,851 – $1,867,274

High-Cost Areas: 

One Unit: $970,800

Two Unit: $1,243,050

Three Unit: $ 1,502,475

Four Unit: $1,867,275

If you want to borrow more money than the loan limit for your area you’ll need a Jumbo Loan, which is called a non-conforming loan. 

FHA vs. Conventional Mortgage Insurance 

FHA loans have Mortgage Insurance Premium while Conventional loans have Private Mortgage Insurance.   FHA’s Mortgage Insurance Premium lasts for the life of the loan while Private Mortgage Insurance can be cancelled once you’ve reached 20% equity. 

FHA Mortgage Insurance Premium 

FHA has Mortgage Insurance Premium which is a fee you pay each month when you borrow using an FHA loan.  There are two parts to Mortgage Insurance Premium. 

Upfront Mortgage Insurance Premium: 

FHA charges an upfront fee which is 1.75% of your loan amount. This fee can either be paid out of pocket as part of your closing costs or financed into the loan. The vast majority of FHA loan borrowers roll this cost into the loan. 

Monthly Mortgage Insurance Premium: 

FHA also charges a monthly rate as part of your mortgage payment. This rate is calculated via an annual premium which is equal to 0.85% of the amount you owe. 

As you can see FHA loans have a pretty high cost when it comes to mortgage insurance but these fees do allow the program to continue to operate and help to offset homebuyers who quit paying their mortgage.

This premium also remains on the loan forever. The only way to get out of FHA’s mortgage insurance is to refinance into a Conventional loan. 

Conventional  Private Mortgage Insurance 

Conventional Loan has PMI or private mortgage insurance. Unlike FHA, conventional loans don’t charge an upfront insurance fee. PMI is a monthly charge that’s added into your payment each month. 

There is no set percentage on Conventional PMI like there is with FHA. There are three primary factors that determine how much you’ll pay in PMI on a conventional loan: 

  • Credit Score
  • Down Payment 
  • Debt-to-Income Ratio 

These three factors will determine how much you’ll pay each month, with your down payment and credit score being the most important. 

FHA vs. Conventional Loans Seller Concessions 

Seller concessions are funds the seller contributes to help cover your expenses for buying and financing your home. These expenses known as closing costs typically range from 2%-5% of the purchase price. 

It’s important to note that no one involved in the transaction can help you with your down payment, but the seller can contribute to your other costs. 

FHA Seller Concessions 

FHA allows the seller to contribute to your closing costs.  Whether you put 3.5% down or 10% down, FHA allows the seller to contribute up to 6% of the purchase price towards your closing costs. 

Conventional Seller Concessions 

With Conventional loans, the amount your seller is allowed to contribute to your closing costs is determined by how much you are putting down. 

Less than 10% down: If you’re putting less than 10% down you seller concessions will be limits to 3% of your closing costs. 

10% to 25% : If you’re putting 10%-25% down then the seller can contribute up to 6% of the purchase price toward your closing costs. 

25% or more: If you’re putting 25% or more down, then the seller is allowed to contribute up to 9% of the purchase price towards your closing costs. 

When To Use An FHA Loan

FHA loans are perfect for homebuyers who: 

  • Have lower credit scores
  • Need a lower down payment 
  • Having a higher debt-to-income ratio
  • Have past credit issues

When To Use A Conventional Loan

Conventional loans are great for homebuyers who: 

  • Have higher credit scores
  • Larger down payments
  • No prior credit issues
  • Want to purchase a more expensive home 

Both of these loan programs offer great options for borrowers from diverse backgrounds. Either one or these loan options will beat renting and a 100% fee to your landlord each month in the form of rent. 

If you’d like to discuss either one of these loans and which one would be right for you, one of our loan experts would love to help! 

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