FHA and conventional loans are two common mortgage choices available to prospective homebuyers. Each type of mortgage has features and benefits that suit different types of borrowers. If you are not aware of the difference between FHA and conventional loan options, contact Society Mortgage, and our Loan Officers will be happy to provide you with all the details.
So, is a conventional loan better than FHA loan? If you want to know the conventional and FHA loan pros and cons, here is a detailed outline and comparison.
Minimum Down Payments
FHA loans require a minimum down payment of 3.5% of the purchase price for borrowers with credit scores of 580 or higher. For credit scores between 500 and 579, a 10% down payment is required.
Conventional loans require a down payment of at least 3% to 5%, with 20% often needed to avoid private mortgage insurance (PMI).
If you have a good credit score, both FHA loans and conventional loans can be a good fit, as you will benefit from a lower down payment.
If you want to avoid paying private mortgage insurance, you can make a 20% down payment on the home’s value.
Credit Score
- FHA loans can be accessed with credit scores as low as 580 for maximum financing (3.5% down payment) or 500-579 with a 10% down payment. This makes FHA loans accessible to borrowers with less-than-perfect credit.
- Conventional loans usually require a minimum credit score of 620, with the best rates reserved for scores of 740 or above. These loans are geared towards borrowers with stronger credit profiles.
Good credit scores come in handy because they lower the overall interest rate on your loan. No matter what type of mortgage you choose, a good credit score will always be a helpful boost.
Debt-to-Income (DTI) Ratio
FHA loans allow for a maximum DTI of 43%, but can go up to 50% for borrowers with compensating factors like a higher credit score or substantial cash reserves. If you have money aside, consistent employment, or can show that you can repay your loan, you could get away with a DTI on the higher end of the spectrum.
Conventional loans cap DTI at 43%, though some programs may allow up to 50% for strong borrowers with compensating factors. Compensating factors are savings, cash reserves, and a strong employment history.
Mortgage Insurance
FHA loans require an upfront mortgage insurance premium of 1.75% of the loan amount and an annual premium of 0.85% for most borrowers. This mortgage insurance is required for the life of the loan if the down payment is less than 10%. If you can afford a 10% down payment, you will pay less in mortgage insurance and your monthly payments will be lower, as you will be required to pay mortgage insurance for 11 years. As for the mortgage insurance premium, it can be rolled into the loan itself.
Conventional loans require private mortgage insurance (PMI) if the down payment is less than 20%. If you put a down payment of more than 20%, you won’t have to pay PMI. PMI can be removed once 20% equity is reached, either through paying down the loan or home value appreciation. PMI ranges between 0.5% to 1.5% of the loan value.
When calculating mortgage insurance, consider not just the monthly payment, but also how long you’ll be required to pay it. While FHA loan insurance is often cheaper on a monthly basis, especially for borrowers with lower credit scores, the fact that it’s required for the life of the loan (in most cases) can make it more expensive in the long run compared to conventional loan PMI, which can be removed.
Mortgage Rates
FHA loans have competitive rates, often lower than conventional loans, especially for borrowers with lower credit scores. The trade-off is the mandatory mortgage insurance.
Conventional loan rates vary widely based on the borrower’s credit score, down payment, and other factors. They may be higher than FHA loans, especially for borrowers with lower credit scores, but could be lower for those with excellent credit.
Property Standards
FHA loans require properties to meet the HUD’s minimum property standards for safety and habitability. These standards are stricter than those for conventional loans and may require repairs before the loan can close.
Conventional loans have more flexible property standards, though the home must still be in reasonable condition. The appraisal process is less intensive than for FHA loans.
Refinancing
FHA loans provide several refinancing options, including the FHA Streamline Refinance for existing FHA borrowers, which can be done with limited credit documentation and often without a new appraisal.
Conventional loans come with different refinancing options, including rate-and-term refinances and cash-out refinances. The process requires full underwriting, including a new appraisal and credit check.
FHA loan refinancing is cheaper and more straightforward than conventional loan refinancing.
Is FHA Better Than a Conventional Loan?
If you are about to buy a home and are still undecided between an FHA and a conventional loan, you should consider your financial circumstances, including your credit score, savings for a down payment, the condition of the property you want to buy, and your long-term financial goals:
- FHA loans can be an excellent choice for borrowers with lower credit scores or limited funds for a down payment.
- Conventional loans might be more fitting for those with stronger credit profiles and the ability to make a larger down payment.
As a professional mortgage lender, Society Mortgage offers both FHA and conventional loans. Our loan officers are here to explain the conventional vs FHA loan comparison in detail and make sure you understand the pros and cons of each option. If you are wondering “Should I get an FHA or conventional loan?”, call us today, and we’ll help you choose the best option for your needs and financial profile!
