So, you’re ready to take the plunge and buy a home? You will definitely need to sort through your options for financing the purchase. To get started, let’s compare two popular options: FHA loans and conventional loans. Scroll down to explore the difference between FHA and conventional loans.
The Difference Between FHA and Conventional Loans
Exploring the difference between FHA and conventional loans starts by defining what they are.
As the U.S. Department of Housing and Urban Development (HUD) explains, FHA loans are home loans insured by the Federal Housing Administration (FHA), which is part of HUD. Helping Americans become homeowners since 1934, FHA loans are made by private lenders in accordance with terms laid out by the FHA.
What about conventional loans? As Experian indicates, these home loans are also made by private lenders, but they are not guaranteed by a government agency. They’re much more common than government-backed loans; in fact, they’re the most popular type of home loan (source).
What differences separate an FHA loan from a conventional loan?
The Challenge of Getting Approved
FHA loans were created to help people become homeowners, and the governmental guarantee that comes with them reduces the risk that lenders take when they make them. As a result, getting approved for an FHA loan is less of a challenge. As SmartAsset reports, you don’t need perfect credit to get approved, and the waiting period after negative credit events like bankruptcy or foreclosure is shorter. In fact, if qualifying with your own credit is tough, you may be able to enlist the help of a non-occupying coborrower. If you do so, the lender will consider your combined financial situations when determining your credit-worthiness for the loan. In contrast, lenders save the best interest rates and terms for borrowers with excellent credit when they’re making conventional loans, and the credit and income standards are generally much stricter.
Your income, credit, and financial resources will play a role in determining how much you can borrow. The type of loan you choose will too. Each year, the Federal Housing Finance Agency releases conforming loan limits for loans that can be purchased by Fannie Mae and Freddie Mac. While not all conventional loans are conforming, lenders prefer to issue this type of loan, so these conforming loan limits often set the threshold for how much you’ll be able to borrow if you want a conventional loan with great terms. As MillionAcres reports, the national limit for conforming loans for a one-unit property in 2020 is $510,400. For FHA loans, the national limit is noticeably lower: $331,760. While the limit rises for both loan types in high-priced housing markets, the FHA limit remains significantly lower, which can limit your buying power.
When it comes to down payments, it may seem like there’s not a lot of difference between FHA and conventional loans. As Credit.com reports, FHA loans require a down payment of at least 3.5 percent. Meanwhile, conventional loans that require a down payment of 3 percent are available. However, your down payment also impacts your mortgage insurance requirements, and there are more differences to be found there . . .
NerdWallet offers a helpful breakdown of mortgage insurance requirements. When it comes to FHA loans, mortgage insurance is always required, and FHA mortgage insurance premiums are the same no matter what your credit score is. In addition, borrowers who make down payments of less than 10 percent will have to pay for FHA mortgage insurance for the life of their loan. You’ll need to refinance to escape it. Conventional loans take a different approach. Lenders generally require borrowers who put down less than 20 percent to pay for private mortgage insurance. PMI premiums vary, and borrowers with good credit may find that PMI payments would be lower than FHA mortgage insurance premiums. Plus, PMI can be canceled when your home equity equals 78 percent.
At PrimeLending of Denver, we’re delighted to offer a wide array of home loan products. After all, the most effective financing doesn’t rely on cookie-cutter solutions. It involves identifying the right loan for each client’s unique needs. Whether you’re interested in a government-backed loan program like the FHA loan program, a conventional loan, or refinancing, we’re ready to work with you to find the best path forward. Contact us today to learn more about our services.