FHA vs Conventional Loan: Which Is Better?

When embarking on the journey of purchasing a house, an early decision to make is the choice of mortgage loan to facilitate the payment to the home seller. It’s important to understand that various types of home loans exist, each presenting unique pros and cons. 

Let’s delve into two primary loan categories: conventional loans and those provided by the FHA loan program.

What Is An FHA Loan?

An FHA loan, backed by the Federal Housing Administration, offers less-restrictive qualifications, making it ideal for those concerned about down payments or lower credit scores. 

These government-backed loans differ from conventional ones, as borrowers are not held to the standards typically imposed by Fannie Mae and Freddie Mac. FHA loans come in fixed-rate or adjustable-rate options.

What Is A Conventional Loan?

Conventional loans, offered by private lenders without direct government backing, differ from FHA loans as they lack government insurance or guarantees. Qualification typically requires a higher credit score, lower debt-to-income ratio, and a slightly larger down payment.

These loans can be conforming or nonconforming. Conforming loans adhere to Fannie Mae and Freddie Mac standards, ensuring consumer protections, with limits that must not be exceeded. Nonconforming loans, such as jumbo loans, cater to those aiming to purchase homes surpassing conforming loan limits. Rocket Mortgage® provides Jumbo Smart loans, maintaining consumer protections with elevated loan limits.

Both FHA and conventional loans come in fixed-rate or adjustable-rate mortgage options. While the usual repayment terms are 15 or 30 years for home loans, conventional loans extend from 8 to 30 years. Despite the common notion that FHA loans suit first-time buyers and conventional loans are for experienced buyers, each loan type carries advantages and disadvantages for all buyers. A detailed comparison of various elements like credit scores, down payments, interest rates, appraisal procedures, and loan limits will be explored below.

See What You Qualify For

FHA versus Conventional Loans: Impact of Credit Score

Your credit score can fall anywhere between excellent (800 and above) and poor (350 – 579), determined by your credit history and other factors. The higher your credit score, the lower the risk you pose, leading to better qualification rates. Lenders typically assess your FICO® Score, ranging from 350 (low) to 850 (high), developed by the Fair Isaac Corporation. They may also consider VantageScore®, an alternative credit scoring model. Your credit information is reported by the three major credit bureaus: Experian™, Equifax®, and TransUnion®.

When applying for a loan individually, the median score from the three bureaus is the qualifying score. For joint applications, the qualifying score is usually the lowest median score among the applicants. There’s an important exception, which we’ll discuss shortly.

Several factors contribute to your credit score, including payment punctuality, credit utilization, credit history duration, new credit accounts, and credit types. The credit score required to secure a loan varies based on the loan type.

Conventional Loan Credit Score Requirements

Credit score requirements for a conventional loan vary depending on the lender. However, you generally need a minimum credit score of 620 to qualify for a conventional mortgage. This is based on your median score as an individual. If you have a co-borrower, Fannie Mae often looks at things a little differently than other mortgage investors. They take the average median score of all borrowers on the loan rather than the lowest median score. This can make it easier to qualify.

If your co-borrower has a median score of 580 and you have a median score of 720, in the past, both incomes couldn’t be used to qualify for a conventional loan. Now Fannie Mae averages the two, making the qualifying score 650.

It’s important to note that for your interest in mortgage insurance cost, the lowest median score is still what counts, so you could have a slightly higher rate. Additionally, this doesn’t apply to every loan option offered by Fannie Mae.

FHA Loan Credit Score Criteria

To be eligible for an FHA home loan, a credit score as low as 500 can qualify you, with some conditions. For instance, a minimum 10% down payment is required for an FHA loan with a 500 credit score. The higher your credit score, the lower the down payment needed for an FHA loan. Typically, most FHA lenders, like Rocket Mortgage, stipulate a credit score of 580 and above for borrowers. The qualifying credit score is the lowest median score if there’s a co-borrower; for an individual, it’s the middle score.

FHA versus Conventional Loans: The Difference in Down Payments

Explore the precise details of the required down payment for each loan type.

Conventional Loan Down Payment

To qualify for certain conventional loans, a minimum 3% down payment is necessary, while most conventional loans mandate a 5% down payment. 

There’s a common misconception that a 20% down payment is a prerequisite for a mortgage loan. Although a 20% down payment is ideal as it helps avoid private mortgage insurance (PMI) premiums, it’s not mandatory. 

Opting for a smaller down payment increases the risk, which can be mitigated by purchasing mortgage insurance. PMI payments are conveniently included in your monthly mortgage payments, ensuring a smoother financial process.

FHA Loan Down Payment

For an FHA loan, a down payment of 3.5% suffices with a credit score of 580 or above. If your credit score falls between 500 and 579, a 10% down payment is required. Here’s a breakdown of down payments for each loan type:

• Conventional loan: 3% down payment on a $500,000 house equates to $15,000.
• FHA loan: 3.5% down payment on a $500,000 house amounts to $17,500.

FHA Vs. Conventional Loans: Interest Rates

Mortgage interest rates are influenced by key overarching factors:

• Federal Reserve’s Influence
• Economic Landscape:
• Investor Sentiment

While these factors certainly come into play, it’s crucial to shift your focus to the financial aspects within your control. Lenders evaluate your credit score, loan amount, down payment, mortgage type (adjustable- or fixed-rate), and the inclusion of discount points.

Adjustable-rate mortgages (ARMs) entail monthly payment fluctuations post the initial fixed-rate period, aligning with prevailing interest rates. Conversely, fixed-rate mortgages maintain a constant interest amount and payment until full repayment.

Discount points, paid upfront to lenders, secure reduced interest rates. Investing in discount points translates to lower monthly mortgage payments throughout the loan’s duration.

Interest Rates for Conventional Loans

Conventional loan interest rates are influenced by factors within your control, such as your credit score and loan-to-value (LTV) ratio. The LTV ratio denotes the loan amount relative to the property value used as collateral.

Interest Rates for FHA Loans

FHA interest rates often offer greater competitiveness than conventional mortgages due to the government’s backing of the loan, reducing the risk for lenders. Your specific interest rate is influenced by various factors, such as prevailing market rates, your income, credit score, the intended loan amount, your down payment, and other considerations.

FHA Versus Conventional Loans: Understanding the Appraisal Process

The appraisal process stands out as a significant distinguishing factor between the two loan types. In a competitive housing market, sellers may opt to steer clear of offers supported by FHA loans due to this aspect.

Conventional Appraisals

When purchasing a home using a conventional loan, your lender will likely mandate a home appraisal. While some programs permit hybrid appraisals or property inspection waivers, the primary goal is to ascertain that the property holds adequate value. This ensures that in the event of a foreclosure and subsequent sale, the lender can recover their losses effectively.

FHA Appraisals

FHA appraisal standards, also utilized by the Department of Veterans Affairs (VA) and U.S. Department of Agriculture (USDA) loan programs, exceed the requirements of conventional lenders.

Listing agents, who act on behalf of sellers, might caution against offers supported by FHA loans due to their stringent appraisal criteria. The delayed appraisal approval and valuation can significantly prolong the selling process, forcing sellers to restart and disclose any FHA appraisal findings to prospective buyers in the future.

FHA versus Conventional Loans: Understanding Loan Limits

Both conventional and FHA loans come with specific loan limits, indicating that you must adhere to these set amounts for each loan type.

Conventional Loan Limit

The 2024 conforming loan limit will be $766,550, with higher limits at $1,149,825 in select areas, like the District of Columbia and states such as California, Colorado, Connecticut, and others. If you’re seeking a home loan surpassing these limits, the jumbo loan option is worth considering. Jumbo loans typically come with stricter underwriting criteria due to their larger size.

FHA Loan Limit

FHA loan limits are adjusted annually based on location in the U.S. For instance,

in low-cost areas like rural Missouri, the upper limit stands at $498,257, while in high-cost regions such as Orange County, California, it goes up to $1,149,825.

To find out your county’s specific limit, simply visit the HUD website dedicated to FHA mortgage limits. Opting for an FHA loan instead of a conventional one means being mindful that these limits could restrict your home purchasing power.

FHA versus Conventional Loans: Understanding Mortgage Insurance

Mortgage insurance safeguards the lender in case of loan default.

Mortgage Insurance for Conventional Loans

Opt for a down payment below 20%, and you’ll be required to cover Private Mortgage Insurance (PMI), available in various forms.

• Split Premium: Another choice is a split premium, combining an upfront payment with a monthly premium; ideally, the seller covers the upfront premium.
• Lender-Paid PMI: Under lender-paid PMI, your mortgage insurance is included in your monthly principal and interest payment, achieved through a slightly higher interest rate. While this can benefit many borrowers, remember that canceling lender-paid PMI is only possible through refinancing or selling your home.
• Monthly Premium: The most common method involves paying a monthly premium, calculated by dividing the annual rate by 12.
• Single Premium Policy: Alternatively, you can opt for a single premium policy, requiring an upfront payment.

FHA Mortgage Insurance for Loans

A Mortgage Insurance Premium (MIP) is mandatory for FHA loans. Typically, this insurance remains throughout your loan’s duration unless you make a down payment of 10% or more, in which case the MIP requirement ends after 11 years. Initially, you’ll pay an Upfront Mortgage Premium (UFMIP) of around 1.75% of your loan amount.

Additionally, MIP payments of about 0.15% to 0.75% of your loan amount are ongoing. The exact figure depends on your mortgage term, Loan-to-Value (LTV) ratio, total loan amount, and down payment size.

When Opting for a Conventional Loan is the Wise Choice

Every situation is unique, yet to apply for a traditional loan, your qualifications or preferences should align closely with the following criteria:

• Your Debt-to-Income ratio (DTI) should be under 50%, assessing your monthly debt payments against your gross income.
• Seeking flexible repayment options.Minimum credit score required is 620.
• You need a down payment of 3% or 20% to avoid PMI.

When an FHA Loan is a Wise Choice

An FHA loan is an ideal choice for individuals who meet the following criteria:

• If you have a lower credit score.
• If you lack sufficient funds for a down payment.
• If your Debt-to-Income ratio is on the higher side. In certain cases, FHA loans can be approved with a DTI as high as 57%.

Common Questions Regarding Conventional Loans Versus FHA Loans

Explore the common queries on conventional versus FHA loans.

What is the preferable choice between FHA and conventional loans?

Choosing the right loan option depends on various factors like your credit score, savings for a down payment, and debt-to-income ratio. If you have a solid credit score, saved for a down payment, and a low DTI, a conventional loan may suit you best. On the other hand, if you’re facing challenges with your credit score, DTI, and down payment funds, an FHA loan could be more suitable.

What are the reasons behind sellers favoring conventional loans over FHA loans?

Home sellers may opt for conventional loans over FHA loans because of the stringent appraisal process associated with the latter. An FHA loan appraisal may unearth more home issues, potentially causing delays in the sale process as sellers address them.

Which loan option incurs higher costs: a conventional loan or an FHA loan?

The comparative costliness of loans hinges on two factors: the overall mortgage expense and the size of your down payment. Note that while an FHA loan entails mortgage insurance payments, opting for a conventional loan with a 20% down payment exempts you from this. For an estimate of your monthly payments, leverage our mortgage calculator.

Key Insight: Two Paths to Homeownership

Deciding on the most suitable loan involves grasping your financial status and requirements. Assess the advantages and disadvantages alongside your eligibility to make the optimal choice for your future self.

Ready to kick off your home loan approval journey? Apply online now and allow us to assist in determining the ideal option for you.