Many steps of the home buying process seem like a colossal undertaking and choosing the right loan may be one of them. You might have friends and family in your life telling you to look into this loan or talk to that lender, all of which might make you feel a little lost.
No one knows your financial situation like you do— which is why it’s essential to thoroughly research all your options before deciding on a plan of action. In this article, we’ll break down two of the most common types of home mortgages— conventional loans and FHA loans— as well as their major differences.
Conventional vs. FHA Loan
They may achieve the same goal, but there is a difference between FHA and conventional loans.
What is an FHA loan?
An FHA loan is a type of home mortgage that is backed by the Federal Housing Administration. Because these loans are insured by the government, lenders are protected from losses should the borrower fail to make their payments.
These loans, which are provided by FHA-approved lenders, give low- to moderate-income borrowers the opportunity to purchase a home, even with lower credit scores or limited down payment savings.
What is a conventional loan?
Conventional loans are the most popular and easy-to-find loan option. Unlike FHA loans, conventional loans are not guaranteed by the government. Instead, lenders assume all the risk when making these loans. Because of this, they often have stricter qualification requirements, including a better credit score and a larger down payment.
An important clarification: many lenders resell conventional loans to third parties, including Fannie Mae or Freddie Mac. These mortgages—the ones being resold—need to meet the basic requirements for resale. Those requirements are not as stringent as FHA loan requirements.
Conventional loans typically come with more flexibility and options. Oftentimes, they can be crafted to meet a borrower's unique needs.
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Who backs the loan?
FHA loans are backed by the federal government.
Conventional loans are not backed by any entity, meaning the lender assumes all the risk.
Minimum credit scores
FHA loans can be obtained with credit scores as low as 580, or in some cases, 500 with a down payment of at least 10%. Please note: this is the minimum standard, but lenders can have more stringent requirements.
Conventional loans typically require a minimum credit score of 620 to 640. Higher credit scores can earn borrowers lower interest rates.
Down payment requirements
You can get an FHA loan with as little as 3.5% down.
Down payment requirements depend on the loan and lender. Borrowers may obtain some conventional loans with as little as 3% down. Keep in mind that 20% or more down typically gets borrowers the best interest rates.
Your debt-to-income ratio must be below 50% to qualify for an FHA loan.
For conventional loans, lenders want to see a DTI of no more than 43%— sometimes even less.
FHA loans have a maximum limit of $420,680 in most Texas counties. Some higher-priced areas like Austin have a limit of $483,000.
In Texas, conventional loans have a limit of $647,200. Buyers can borrow more than this amount using a loan known as a jumbo mortgage.
Borrowers must pay a mandatory mortgage insurance premium (MIP) regardless of down payment. If you put 10% or more down, you don’t have to pay MIP after 11 years of repayment; otherwise, you must pay MIP for the life of the loan.
Conventional loans often require private mortgage insurance (PMI) if the down payment is less than 20%. If borrowers put less than 20% down, they can request to stop PMI payments once they reach 20% equity.
Property must meet FHA standards of safety, security, and soundness.
There are few, if any, property requirements for conventional loans.
There is a special FHA appraisal required.
The normal appraisal process is all that is needed.
Who is a conventional loan best for?
Conventional loans are the most common type of loan and are suitable for most borrowers. They can be used for anything from a second vacation home to a fixer-upper and are accessible to most buyers with a decent financial standing.
Since conventional loans don’t have to adhere to strict government guidelines, lenders may offer greater flexibility on a case-by-case basis. Even if you think you don’t meet the credit standards for a conventional loan, always be sure to speak to a lender who may be able to work with you or offer a different solution.
Who is an FHA loan best for?
FHA loans get a lot of buzz, especially for first-time home buyers, but the truth is, only a small fraction of homeowners use this type of financing. In 2021, only 10.3% of home loans were FHA.
That being said, there are definitely instances where this type of loan makes the most sense.
FHA loans are best for borrowers who have a less-than-stellar credit history and don’t have a lot of cash on hand for a down payment. If you’ve gone through bankruptcy or foreclosure within the past seven years, this loan will likely be the one you can get approved for.
Because of the relatively low borrowing limit, an FHA loan is typically not the best option for someone living in a more expensive area. For instance, in Central Texas, FHA loans are better suited for those in suburban areas rather than within the city of Austin.
How to Find the Right Loan
Still not sure where you stand? Beyond researching things for yourself online (which it looks like you’re already doing— great!), you can do two things.
- Assess your financial situation.
- Speak to a local lender.
To assess where you stand financially, gather information like your credit score, income, amount of debt, and down payment savings. These are all crucial factors in determining how much you can borrow and what loan you will qualify for.
Having these figures handy will also come in handy when you speak to a loan officer. They will be able to take that information and provide you with advice as to what may be the best options for your unique situation.
The Bottom Line
Before taking out a loan based solely on your friends’ and family’s recommendations, take a minute to consider your financial standing. FHA mortgages are often mentioned, but they aren’t the most common loan product out there. For most buyers, conventional mortgages end up offering better terms and greater flexibility. Always do your research before committing to a loan product and speak to a loan expert who can offer advice based on your personal financial situation.