FHA vs. Conventional Loans: The Right Way to Your Dream Home

Mortgage plays an essential part in your home ownership journey. FHA loans and conventional loans are the most common mortgage types available for home buyers.

Figuring out the best home loan option for your specific financial situation is imperative for a smooth home-buying journey.

In this blog, we explore the basics of FHA and conventional loans. By highlighting their unique features, eligibility criteria, and advantages.

What is an FHA Loan?

An FHA loan is a type of mortgage that helps people buy homes. It is backed by the Federal Housing Administration (FHA). An FHA loan makes it easier for individuals with lower credit scores or a smaller down payment to qualify for a home loan.

FHA Loan Eligibility Criteria

FHA loans have a few requirements you need to meet. However, they are less stern compared to other loans.

• Credit Score and Down Payment: You need a credit score of 580 to qualify for a 3.5% downpayment on an FHA loan. Borrowers with a lower credit score, need a 10% downpayment.
• Evidence of Steady Employment: Mortgage lenders need assurance that you will be able to repay the principal and interest. They will check your employment and income details.
• Mortgage-to-Income Ratio: Your total mortgage expense including mortgage installment, mortgage insurance, property taxes, HOA fees, and homeowner’s insurance. This should be less than 31% of your gross income.
• Debt-to-Income Ratio: Debt includes mortgages and other loans like credit card payments, student loan installments, etc. Your total debt should not exceed 43% of your gross income.
• Cash Reserves: If your debt-to-income ratio is high or your credit score is below the requirement, you have to maintain some cash reserves. These cash reserves should cover a minimum number of mortgage installments determined by the lender.

📌 FHA requirements: Read for more details.

Benefits of an FHA Loan

FHA loans have several benefits for homebuyers. Here are a few –

• Lower Down Payment Requirements: With an FHA loan, borrowers require only a 3.5% down payment to qualify. However, you must have a minimum credit score of 580.
• Lower Credit Score: You only need a credit score of 580 to qualify for an FHA loan. Other types of mortgages require at least a 620 or above score.
• Higher Debt-to-Income Ratio: You can have debt exceeding your income and still qualify for an FHA loan.
• Flexible Income Source: You can include alternative income sources such as alimony or child support to qualify for an FHA loan.

📌 Pros and Cons of an FHA Loan: Read for more details.

What is a Conventional Loan?

A conventional loan is a popular mortgage option that offers flexibility and accessibility to many home buyers. The government does not insure or guarantee conventional loans.

It is offered and backed by private lenders and is subject to their guidelines. This includes conventional loan requirements, such as credit score criteria, downpayment, and interest rates.

Conventional Loan Eligibility Criteria

Since conventional loans are not backed by any government body, you need to meet certain requirements to qualify.

• Credit Score: A credit score of 620 and above can help you quickly qualify for a conventional loan. However, credit score terms depend on the lender and you may be able to qualify with a lower credit score as well.
• Income Proof: You must provide income proof such as pay stubs and tax returns. Lenders need some kind of guarantee about your repayment ability.
• Debt-to-Income Ratio: Most lenders, require a DTI ratio of 43% or lower. However, you can find lenders willing to go with a higher DTI ratio.
• Down Payment: Private mortgage lenders require a down payment of 3% to 20% of the home purchase price. It is calculated based on your creditworthiness and lenders’ requirements.
• PMI: PMI stands for Private Mortgage Insurance. Mortgage borrowers must pay PMI for loans with less than 20% downpayment.
• Appraisal: You need to conduct a professional appraisal of the property before you can get the loan amount. The appraisal will help ensure that the loan amount does not exceed the property’s market value.

Benefits of a Conventional Loan

Conventional loans offer some great benefits, especially for first-time home buyers.

• Flexible Loan Terms: Conventional loans provide a wide range of options in terms of loan terms (e.g., 15-year, 30-year) and interest rate structures (fixed or adjustable rate).
• Cancel PMI: You can request your lender to cancel PMI once you have 20% equity in your home. Moreover, PMI is automatically canceled when your balance reaches 78% of the home selling price.
• Competitive Interest Rates: Conventional loans, reward higher credit scores with a lower interest rate.
• Low Down Payment: First-time home buyers can avail of a conventional loan with a down payment as low as 3%. However, you must pay PMI which will increase your monthly payment.

What are the Differences Between FHA and Conventional Loans?

Should you get an FHA or a conventional loan? The answer depends on your specific financial situation and your home loan requirements.

Here is an FHA vs conventional comparison chart –

FHA vs Conventional: Credit Score

One of the significant differences between FHA and conventional loans is the credit score requirement.

FHA loans are easy in this aspect and allow borrowers with credit scores as low as 500 to qualify for a loan. However, borrowers with credit scores below 580 need at least a 10% down payment.

To qualify for a conventional loan you need a minimum credit score of 620.

FHA vs Conventional Loans: Down Payment

FHA loans are popular among first-time home buyers because it requires only a 3.5% downpayment of the purchase price or appraised value.

For example, if you are purchasing a home for $200,000, the minimum down payment would be $7,000 (3.5% of $200,000).

Conventional loans require a down payment of 3% – 5%. However, this depends on the lender and your creditworthiness. Moreover, if you want to avoid PMI, you must put down at least 20%.

FHA vs Conventional Loans: Debt-to-Income (DTI) Ratios

FHA loans have flexible DTI requirements. You need a 43% DTI ratio to qualify and some lenders may even go up to 45% or 50%.

Lenders are stricter about conventional loans. A good DTI for a conventional loan is between 36% – 43%. However, some lenders could agree to go up to 45% – 50%.

FHA Vs. Conventional Loans: Interest Rates

You pay a higher interest rate on a conventional mortgage vs an FHA loan. However, the FHA rate can be higher than a conventional loan in case of a low credit score.

FHA mortgages are insured by the government, which provides some level of protection for lenders in case of default.

Since conventional loans are not backed by the government it is risker for lenders. However, borrowers with strong credit profiles and larger down payments are rewarded with more favorable interest rates!

FHA Vs. Conventional Loans: Loan Limits

An FHA loan limit is the maximum amount of money that a borrower can borrow using an FHA loan. These limits are set by the Federal Housing Administration, a part of the Department of Housing and Urban Development (HUD).

FHA loan limits in low-cost counties –

Single	Duplex	Tri-plex	Four-plex
$472,030	$604,400	$730,525	$907,900

FHA loan limits in high-cost counties –

Single	Duplex	Tri-plex	Four-plex
$1,089,300	$1,394,775	$1,685,850	$2,095,200

Conforming loan limits 2024 on the other hand can shoot past $1 million in high-cost areas. The conventional loan limit for low-cost areas is $726,200.

Conforming loan limits in low-cost counties –

Single	Duplex	Tri-plex	Four-plex
$726,200	$929,850	$1,123,900	$1,396,800

Conforming loan limits in high-cost areas –

Single	Duplex	Tri-plex	Four-plex
$1,089,300	$1,394,775	$1,685,850	$2,095,200

FHA vs. Conventional Loans: Mortgage Insurance

With an FHA loan, mortgage insurance is required for the entire life of the loan. This means that borrowers with an FHA loan must pay a mortgage insurance premium (MIP) with the monthly mortgage payment.

In contrast, conventional loans typically require private mortgage insurance (PMI) if the borrower puts down less than 20% of the home’s purchase price.

However, once the borrower reaches 20% equity in the home, they can request to have the PMIbb removed.

Bottom Line

If you’re a first-time home buyer, it’s important to understand the differences between FHA loans and conventional loans.

FHA loans usually ask for a smaller down payment, like 3.5% of the house’s price, which can be helpful if you don’t have much money saved up.

However, if you are looking a buy a more expensive property, a conventional loan will be a better option for you.

Think about your financial goals, monthly budget, and property requirements before deciding on the type of mortgage you need.

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Frequently Asked Questions

Also Read

• Fixed-Rate Mortgage: Everything You Need to Know.
• FHA 203(k) Loan: Learn How to Apply for it.
• Real Estate Market Analysis: Market research is the first step any investor must take before entering the market. Read more to know about it.

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