Many people spend years dreaming of owning their own home, but feel it’s out of their grasp. Homes cost hundreds of thousands of dollars, but you can get a mortgage that allows you to borrow against the value of the home.
There are many types of mortgage loans available, but the most common are conventional loans vs. FHA loans. Potential homeowners examine both to get their mortgages, but which one is right for you? We created this guide to investigate the ins and outs of each loan type, so you can make an educated decision on your preferred loan.
Conventional Loans Vs. FHA Loans: The Basics
When you go to a bank or other lender, the first loan you’ll try for is a conventional loan. This loan is held by the lender and your collateral is the home you buy. The lender gets your information, checks your credit score, and determines if you qualify for a loan, how much, and at what interest rate.
A conventional loan is secured, and you pay your mortgage payment every month for 15 to 30 years, depending on the loan duration. Conforming mortgages follow dollar limits the government agencies Freddie Mac and Fannie Mae. Nonconforming mortgages go beyond those dollar amounts and are too large to be guaranteed by Freddie and Fannie.
Congress created the Federal Housing Authority in 1934 during the Great Depression to help people purchase homes during a time when it was difficult. Through the years, it has evolved into a loan program designed to help people who don’t qualify for conventional loans get the money needed to purchase their own house.
Fannie Mae and Freddie Mac regulate conventional mortgage loans. FHA loans are insured by the organization, so if you are unable to make payments, the FHA comes in and takes care of it. It requires less risk on the bank since they know no matter what, someone pays the loan.
FHA and Conventional Loans: Credit Scores
One of the most important aspects of a conventional home loan is your credit score. When you begin creating credit whether it’s a car loan, credit card, etc., the three credit bureaus begin collecting that information and create a credit report and score.
Conventional loans require a higher credit score to qualify for a loan. The higher the score, the more you can borrow and at a lower interest rate. If your score is too low, you cannot get a conventional loan.
An FHA loan is for people who don’t qualify for a conventional loan, or the conventional loan payment is unaffordable due to lower credit scores. FHA can accept credit scores as low as 500, but they would ideally like it to be around 620 or higher. If you have a credit score below 580, then you’ll need a 10 percent down payment on the home.
Both loans provide fixed and adjustable interest rates, but your credit score has a tremendous impact on the rates for your loan. So, while you may qualify for the FHA loan, the interest rates are higher than a conventional loan.
FHA and Conventional Loans: Down Payment
The general rule is the more you can put down as a down payment, the better off you are. You immediately have equity in your home, and you decrease your monthly payments. For a conventional loan, you can submit as little as 3 percent of the value of the home.
Anything under 20 percent, requires purchasing private mortgage insurance.
You only need about 3.5 percent for an FHA loan, but if the down payment is less than 10 percent, then you’ll need to pay upfront mortgage insurance, which is another 1.75 percent, rolled into the loan.
Mortgage Limits for FHA and Conventional Loans
The government has a formula for maximum conventional loan limits with most states maxing out at $548,250 and $822,375 for places with higher costs of living such as Alaska, Hawaii, etc.
FHA loans have smaller maximums depending on your area with a single-family home maxing out at $356,363, but that increases for more expensive markets.
One thing to consider is just because you can get a loan for that amount, do you need a home that expensive. Remember, you need to come up with the monthly mortgage payment as well as utilities and other monthly bills.
FHA and Conventional Loans: Insurance
Standard or conventional loans require private mortgage insurance if your down payment is less than 20 percent. When you get the loan, your lender works with you to choose a private insurance company. The premium is added to your monthly payment or paid upfront.
Since the FHA insures your home, there isn’t a need for mortgage insurance. Instead, you get an insurance premium. You pay a one-time upfront premium and then a premium every year. The annual premium is spread out over 12 months and added to your monthly payment.
Appraisals Under FHA and Conventional Loans
No matter what type of loan you get, you’ll need an appraisal. With a conventional loan, the appraiser determines the value of the home. For an FHA loan, the appraiser not only determines the value but also looks for health and safety issues such as ventilation issues, peeling paint, etc.
If the appraiser discovers health and safety issues, they must be fixed before approval for the FHA loan.
Choose the Loan That Fits You Best
When it comes to conventional loans vs. FHA loans, it’s about what you qualify for. If you have a great credit score and a good-sized down payment, then you likely want a conventional loan. If your credit isn’t great and you have a low down payment, then apply for an FHA loan.
If you want to learn more about FHA and conventional loans, then please contact our experts today.