FHA vs Conventional Loans – What’s the Difference?
This feels like the age old question in the mortgage industry especially for buyers with low down payments. You’re not a veteran so you don’t qualify for a VA loan. You’re not looking for a jumbo loan (above conventional loan limits). So lots of buyers have the option between an FHA mortgage and a conventional mortgage. Everyone’s scenarios are unique but below is some information on each loan program.
A Few Conventional Mortgage Benefits
- No Upfront Mortgage Insurance
- 620 Minimum Credit Score (although higher score recommended)
- Loan Limits are typically slightly higher than FHA
- Multiple Different Mortgage Insurance Options including no monthly mortgage insurance with Lender Paid MI (if putting less than 20% Down)
- If you have monthly mortgage insurance, it’s not permanent – allowing you to drop your payments down the line
- No Mortgage Insurance Required (if putting 20% down or more)
A Few FHA Mortgage Benefits
- Government loan program backed by HUD
- Lower rates than conventional
- 580 Minimum Credit Score with 3.5% down (can even go to to 500 credit score up to 90% LTV if qualified)
- Typically has more lenient guidelines for credit and income requirements (allows for lower credit and higher debt to income ratios)
You can use this tool to find the FHA loan limits in your area!
A Few FHA Drawbacks
- Upfront mortgage insurance premium (1.75% of loan amount) is rolled into the loan (or can be paid out of pocket) on every single FHA loan
- Monthly mortgage insurance is required no matter what down payment
- If putting less than 5% down, monthly mortgage insurance is permanent (but does decrease as the loan amount decreases)
Rule of Thumb Scenarios
Everyone’s situation is different but below are a few scenarios where it’s almost always the right choice.
- If you’re putting 20% down or more with 640+ credit score, conventional is likely the best option for you
- Or if you’re putting 5% down or more with 720+ credit score, conventional is likely the best option for you
- If you have below a 580 credit score or above a 50% debt to income ratio, FHA is likely the best option for you
- And if you have less than 10% down payment and less than a 680 credit score, FHA is likely the best option for you
Scenarios Where FHA vs Conventional Can Be A Tough Decision
We help analyze all options for our clients. However, the toughest decisions are for borrowers that have between a 680 and 720 credit score. This is because FHA and conventional can be pretty comparable. Buyers might have to decide between a lower rate and slightly lower payment now with FHA vs paying a slightly higher mortgage payment now in order to drop off mortgage insurance down the line.
Conventional Programs for Low/Moderate Incomes Help Compete with FHA
Fannie Mae and Freddie Mac both have programs that offer special interest and mortgage insurance rates for borrowers with income less than the median income for the county. These programs are known as HomeReady (Fannie) and HomePossible (Freddie). These make it an easier decision for someone with 3-5% down to go conventional because of the discounts involved.
Why go with a Conventional Loan if FHA has better rates?
This question is asked a lot to mortgage lenders and brokers nationwide. Unfortunately, there are some predatory lenders that try to convince people to get an FHA loan without looking at the full . Just because a loan program has the lowest rate does not mean that it is the best loan program for you. Many times conventional loans will offer lower monthly payments (and total cost) for borrowers with large down payment or great credit with a higher rate than FHA. This is because with conventional in this scenarios, your monthly mortgage insurance is likely much cheaper than it eats away at the rate savings. Also, with conventional there is no upfront mortgage insurance and the mortgage insurance (if required) isn’t permanent either.