Thinking about purchasing your first home but still unsure about whether an FHA loan or conventional loan is best for you? While both are the leading product selections for borrowers wanting a low down payment, there are distinctions that may sway you to one loan product versus the other. FHA vs. conventional
The first thing we need to understand is what is an FHA loan’s main objective?
An FHA mortgage loan is insured by the Federal Housing Administration. This loan provides easier credit qualifying guidelines than all loans available. As a result its become an attractive choice for borrowers with lower credit scores and those with minimal down payment funds.
In contrast, conventional loans are not fully insured by any government agency and have stricter qualifying guidelines established by private lenders. Conventional loans include jumbo loans too. Jumbo loans are amounts over the conforming loan limit.
Conforming loans have conditions made by Fannie Mae and Freddie Mac, the two government-sponsored enterprises that buy conforming mortgages from lenders.
In general, conventional loans have tighter qualifying requirements in comparison to FHA loans.
Credit Score Differences in FHA vs. conventional
For either an FHA or conventional loan, lenders need to know your FICO credit score whichever loan choice you decide on.
With an FHA loan as low as 500 credit scores may be eligible provided that the borrower is able to bring in a 10 percent down payment. That said, if you have a 580 or above credit score, the down payment condition decreases to 3.5%, and the interest rate will be better.
Almost all conventional mortgage lenders have criteria that the borrower have a minimum 620 credit score to get approved. As with any mortgage loan, the higher your credit score, the lower your interest rate will be.
Keep in mind that if you have a bankruptcy you must wait four years to apply and as much as seven years following a foreclosure.
Down Payment Requirements- FHA vs. conventional
Conventional loans require a minimum of 3% down payment despite the popular perception that 20% is required. Although, this requirement may differ from one lender to the next. Some bank and mortgage lenders will have overlays and lend conservatively by requiring 5 or 10% down payments from their borrowers.
Take into account that if when you bring less than 20% down, you’ll need to pay PMI (Private Mortgage Insurance) premium until the loan to value reaches 80 or less. This means your home’s value must increase to 20% more than what you bought it for.
A 10% down payment is the requirement for FHA homebuyers with a credit score between 500 and 579. While a 580 credit score makes it possible for a down payment of just 3.5%.
Debt to Income (DTI) Requirements
Your DTI is the percentage of your monthly income that is used to make payments on your debts such as your car or truck, student loans, credit cards, personal loans and your housing payment. It’s calculated by dividing your total debt by your gross income.
Similar to their easy credit score guidelines, FHA loans also have less strict DTI requirements. The maximum DTI for FHA loans is 57%. Although, in some cases it may be less after an underwriter reviews your application.
There’s not a DTI ratio etched in stone for conventional loans but for the most part, you’ll want a DTI of 50% or under. Having said that, there are several scenarios where borrowers may still qualify with a DTI with as much as 65%.
FHA and conventional loans have loan limits that adjust annually, according to whether home prices appreciate or decline.
FHA Loan Limits
For 2022, the maximum loan amount for an FHA loan is $420,680. It can go as high as $970,800 if you are in a high-cost area in the U.S.
Conventional Loan Limits
In 2022, the maximum conforming loan amount is $647,200, with a cap of $970,800 for high-cost areas on single family, condo or townhouses.
Mortgage insurance protects lenders in case you default on your loan.
You are required to pay MIP (Mortgage Insurance Premium) for as long as you have the FHA loan except if you bring in a 10% or higher down payment, whereby the insurance premium will be removed once eleven years has passed.
If you bring in a down payment under 20% with a conventional loan, you need to pay for PMI (Private Mortgage Insurance). However, PMI may be taken off as soon as your home obtains 20% equity.
Ready to apply?
Deciding on which loan type is best for you can be confusing, and lots of variables confirm which choice is best. The good news is you have licensed lending professionals to guide you about which loan fits your needs and requirements.