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A Federal Housing Administration (FHA) loan or FHA loan is insured by the federal government. First-time home buyers and those with lower credit scores and lower down payments are more likely to qualify for an FHA loan. A conventional loan isn’t insured by the government. It’s instead backed by a private mortgage lender and the borrower usually pays the insurance. Conventional loans can be harder to qualify for and require that the borrower have a higher credit score.

FHA and conventional mortgage loans are the most common financing options for today’s mortgage borrowers. In 2018, 74% of all mortgage loans were conventional loans.1 Butm should you get an FHA or conventional loan and which program makes the most sense for you?

FHA Loan vs. Conventional Loan

The key to deciding which loan you should get is understanding the characteristics of both programs and how they relate to your financial situation. You may be a good candidate for either program. If so, you want to select the loan that aligns with your payment and cash flow needs.

FHA Mortgage Loan Conventional Mortgage Loan
Required Credit Score 500+ credit score 620+ credit score
Credit History Impact on Qualification Shorter wait times after negative credit events, such as foreclosure, short sale, bankruptcy and divorce Longer wait times after negative credit events, though some lenders may be flexible depending on circumstances
Typical Down Payment As low as 3.5% As low as 3%, with advantages for a larger down payment
Mortgage Insurance Requires both a 1.75% upfront premium and 0.45%–1.05% annual premium Either a one-time payment or monthly fees from 0.55%–2.25% depending on credit, may be waived with a 20% down payment
Typical Interest Rate Lower interest rates than a conventional loan Higher interest rates than an FHA loan
Required Debt-to-Income Ratio Higher debt-to-income ratio than a conventional loan Lower debt-to-income ratio than an FHA loan
Typical Approval Timeframe Longer Shorter

 

About an FHA Loan

FHA loans are insured by the FHA. Borrowers pay a mortgage insurance premium in addition to monthly payments. An FHA loan requires two mortgage insurance payments:

  1. An up-front premium calculated at 75% of the loan amount
  2. An annual premium of between 0.45% and 1.05% of the loan amount—depending on the length of the loan

These mortgage insurance payments make an FHA loan more costly. However, an FHA loan is accessible to homebuyers with credit scores as low as 500. Additionally, cosigners are allowed. And the wait times for loan approval after a short sale or bankruptcy tend to be shorter than for conventional loans.

When seeking a government loan, you may hear the terms qualified mortgage loans (QM loans) and nonqualified mortgage loans (non-QM loans). QM loans are safer for your lender and protect the lender from legal action if you fail to repay your loan. Non-QM loans are less safe for lenders and carry higher interest rates and costs. For a single-family primary residence, it’s unlikely you’ll need to consider a non-QM loan. They are typically best for less-common property purchases, such as condominiums that don’t conform to government guidelines.

Should You Get an FHA Loan?

A loan through the FHA program makes sense when you are a first-time buyer, have little equity to work with or have a unique financial situation. You’ll also need at least a 3.5% down payment to purchase a home with an FHA loan.

The program does limit the size of loans it offers. Loans amounts are roughly limited to a maximum loan limit for the county where the home is located. Upper limits are also capped nationally. The upper limit on homes in low-cost counties is capped at $294,515 in 2018. The cap in high-cost counties is $679,650 in 2018. For example, in Sonoma County, California, you can get an FHA loan of up to $648,600 for a single-family home in 2018 while in Napa the limit is the national limit of $679,650.2

About a Conventional Loan

Conventional loans represent the lion’s share of the mortgage market. These loans, while the most popular, also have stricter qualifying guidelines than FHA loans, including a minimum credit score of 620. You also need a minimum down payment of 3%. However, if you can make a 20% down payment, you can avoid paying for private mortgage insurance (PMI). Even if you can’t make the 20% down payment, as long as you have a good credit history, you’ll pay less for PMI on a conventional loan than you will on an FHA loan. And with a conventional loan, wait times after a short sale or bankruptcy tend to be longer than for FHA loans.

The trade-off for these stricter guidelines is that if you don’t have to pay for private mortgage insurance, even with a higher interest rate, you can actually save more over the life of the loan.

There loan limits on the amount you can borrow with a conventional loan. Limits for 2018 are $424,100 for a single-family home.

There are also different types of conventional mortgage loans:

  • A conventional mortgage is, as already described, a private loan not backed by the government.
  • Conforming loans can be sold to other lenders, typically government-sponsored entities (GSEs) Fannie Mae and Freddie Mac because the loan “conforms” to their guidelines.
  • Nonconforming loans don’t conform to GSE guidelines and may be sold to other lenders, but GSEs wont’ buy them. Nonconforming loans are typically large loans, called “jumbo” mortgages.

Should You Get a Conventional Loan?

If you have a credit score of more than 620 and can make a 5% down payment or more, you have the bare minimum needed to apply for a conventional loan. Combine those criteria with a strong employment history and a lower debt-to-income ratio (at a maximum of 40 to 50%) and payment-to-income ratio, and you’re a good candidate for a conventional loan.

Before You Apply for Either an FHA or Conventional Loan

If you’re considering applying for a mortgage loan, it helps to know not only how much house you can afford, but where your credit stands before you begin the process. That’s because your credit scores help determine what types of rates and terms you can qualify for. Get your Experian credit score for free and get an updated score every 14 days on Credit.com.

This article was last published December 1,2017, and has been updated by a different author.

Image: Ridofranz

1 US.S Census Bureau, https://www.census.gov/construction/nrs/pdf/quarterly_sales.pdf

2 U.S. Department of Housing and Urban Development, https://entp.hud.gov/idapp/html/hicost1.cfm

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