Federal Housing Administration (FHA) loans and conventional loans remain the most popular financing types for today’s mortgage borrowers. But which program makes the most financial sense for you?
FHA Loans vs. Conventional Loans
The key to deciding which loan you should get is understanding the characteristics of both programs and how they relate to your financial picture. You could be a good candidate for either program, so select the loan that aligns with your payment and cash flow expectations.
|FHA Loans||Conventional Loans|
|Credit Score||Usually requires 500+ credit score||Usually requires 620+ credit score|
|Credit History||Shorter wait times after derogatory credit events like foreclosure, short sale, bankruptcy, and divorce||Longer wait times after derogatory credit events, though some lenders may be flexible depending on circumstances|
|Down Payment||As low as 3.5%||As low as 3%, though there are advantages for a larger payment|
|Mortgage Insurance||Requires both a 1.75% upfront premium and 0.45%–1.05% annual premiums||Either a one-time payment or monthly fees from 0.55%–2.25% depending on credit, though these could be waived with a 20% down payment|
|Interest rate||Tends to have lower interest rates than conventional loans||Tends to have higher interest rates than FHA loans|
|Debt Ratio||Allows higher debt ratios than conventional loans||Allows lower debt ratios than FHA loans|
|Time for Approval||Often takes longer to process||Often takes less time to process|
The Nuts and Bolts of FHA Loans
FHA loans are insured by the Federal Housing Administration, and borrowers must pay for mortgage insurance. The program requires two mortgage insurance payments: an up-front premium calculated at 1.75% of the loan amount and an annual premium that’s somewhere between 0.45% and 1.05% of the loan amount—depending on the length of the loan.
These mortgage insurance payments make FHA loans pricey. However, the program is flexible for homebuyers with credit scores as low as 500. Additionally, cosigners are permitted, and the wait time requirements for approval after short sale and bankruptcy tend to be shorter than they are for conventional loans.
Should You Get an FHA Loan?
The FHA program makes sense when you have little equity to work with or a unique financial situation. You’ll need at least a 3.5% down payment to purchase a home using an FHA Loan.
The program will go as high as the maximum loan limit for the county where the home is located. For example, in Sonoma County, California, you can get a loan of up to $554,300 for a single-family home.
The Nuts and Bolts of Conventional Loans
Conventional loans represent the lion’s share of the mortgage market. These loans, while the most popular, also contain tighter qualifying guidelines than FHA loans, including a minimum credit score of 620. And with a conventional loan, wait times after short sales and bankruptcy tend to be longer than those for FHA loans.
The trade-off for these strict guidelines is you don’t have to pay for private mortgage insurance if you have a high enough down payment. So even though conventional loans tend to have higher interest rates, you’ll save more over the life of the loan.
Should You Get a Conventional Loan?
If you have a credit score over 620 and a 5% down payment, you have the bare minimum required to apply for a conventional loan. Combine those with a strong employment history and payment-to-income ratio, and you’re a good candidate for the loan.
Remember, if you’re considering applying for a mortgage, it helps to know not only how much house you can afford but also where your credit stands before you begin the process. That’s because your credit scores help determine what types of rates and terms you may qualify for. You can get two free credit scores, which are updated every 30 days, on Credit.com.
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