The home buying process requires many decisions, like which neighborhood to live in and how many bedrooms you’ll need. But not every decision is easy or particularly fun to make, especially when it comes to how you’re going to pay for your new home.
If you’re like most homebuyers, you’re planning to take out a mortgage loan. Two of the most common types of home loans are Federal Housing Administration (FHA) loans and conventional loans. Depending on your credit score, income, and how much money you’re able to put toward a down payment, one option may be more beneficial to you than the other.
So, what is the difference between a conventional loan and an FHA loan? We’ve created this guide to help you understand the requirements, as well as the pros and cons, of each.
What is a conventional loan?
A conventional loan is a mortgage loan that is not backed by a government agency. You can get a conventional home loan from a bank, or through a private lending company like Associates Home Loan.
Because conventional loans are not insured by the government like FHA loans, they have stricter requirements in order to protect lenders. To qualify for a conventional loan, you’ll need:
- A good credit score. Most conventional loans require a credit score of at least 640, but some lenders may require a score of 660 or more.
- Low debt-to-income ratio. Banks and private lenders want to be sure they’re lending to someone they can trust to pay back the loan. Having a low debt-to-income ratio (DTI), meaning you earn more than you pay in monthly debts (such as rent, car payments, and student loans), is typically required to qualify for a conventional loan. You can calculate your DTI using an online calculator tool.
- Private mortgage insurance. One benefit of conventional loans is that they require lower down payments than FHA loans—the minimum is just 3% of the price of the home. However, if you do decide to put down less than 20% on a mortgage, you will likely be required to pay for private mortgage insurance (PMI). This protects the lender if the buyer defaults and is no longer able to pay the loan in the future.
- Lower interest rates. Because interest rates are in part based on your credit score, buyers with high credit scores who qualify for conventional loans are more likely to enjoy lower interest rates in the long run.
- Higher loan limits. Compared with FHA loans, a conventional mortgage loan allows you to borrow more money to put toward a house. Non-conforming loans called jumbo loans allow buyers to borrow as much as $2 million.
- It’s harder to get approved. Conventional loans have stricter qualifying requirements than government-issue loans because they require private lenders and banks to take on a considerable amount of risk. To ensure that lenders don’t default on their mortgage loans, they take extra measures to check your credit and financial history.
What is an FHA loan?
An FHA loan is a type of home loan that is insured by the US Federal Housing Administration.
There’s a common misconception that FHA loans are only for first-time homebuyers. While it’s true that 83% of people who get an FHA loan are, they can also be a good fit for established buyers who are unable to qualify for a conventional loan due to a previous foreclosure or sudden increase in debt.
To qualify for an FHA loan, you’ll need:
- A DTI ratio below 43%. Your debt-to-income ratio must be below 43% to qualify for an FHA loan. However, FHA loans are more flexible, and exceptions can be made for applicants with higher DTI ratios who also have high credit scores.
- Proof of employment. A steady income is required to pay back a loan, so borrowers must be able to provide proof of employment.
- To buy a primary residence. An FHA loan can only be used to purchase a home you intend to live in as your primary residence. That means it cannot be used to purchase vacation homes, investment properties, or a home you intend to flip and resell within 90 days.
- Easier to qualify for. With far more lenient credit requirements, FHA loans make the dream of homeownership possible for buyers who may otherwise be denied a conventional loan.
- Low down payments. While a good credit score is not a requirement for an FHA, it can help you qualify for a lower down payment. If your credit score is above 580, you only have to pay a minimum down payment of 3.5%.
- Limited housing options. FHA loans limit the amount of money you can spend on a home—in most parts of the country, the limit is currently at around $500,000, but it’s dependent on the cost of living in an area. You can look up your county’s maximum FHA loan limit here.
- Higher insurance costs. All FHA borrowers must pay a mortgage insurance premium (MIP), which is added to your monthly mortgage payments. An upfront MIP must also be paid during the closing process, which is equal to 1.75% of the loan amount.
Learn More About Your Mortgage Loan Options
Overall, the main difference between FHA loans and conventional loans is that FHA loans are specifically to help first-time buyers and buyers with credit challenges afford a home.
However, even if you have bad credit, it’s still possible to get a conventional loan with the right lender. At Associates Home Loan of Florida, we specialize in mortgage solutions for buyers with poor credit, including hard money loans and subprime loans. To learn more about your potential lending options, contact our team of lending professionals.