What is the difference between FHA Loans vs. Conventional Loans?
Both FHA Loans and Conventional Loans are popular loans among homebuyers. It may not always be so clear which loan to get when buying a home. In this blog post, I will be delineating the pros and cons for both FHA and Conventional Loans. This way, the applicant or potential borrower will find it easier to differentiate the two. Furthermore, the potential applicant—YOU—will know which loan to get!
Downpayment and FICO Score
First-time homebuyers usually get FHA loans. It’s faster to qualify for these loans. Also, there is less elapsed time in case of major credit problems such as foreclosures, short sales, bankruptcies, etc. Furthermore, FHA loans require a minimum downpayment of 3.50%. Additionally, the loan limit for FHA loans in certain parts of the country can be as high as $300,000.
FHA requires borrowers to have a minimum FICO credit score of 580. While FHA loan guidelines require a FICO score of 580, individual bankers and lenders may require more or less. If your FICO score is lower than this minimum, the loan requires you to make a 10% downpayment. Hence it’s good to have a higher FICO score, generally. Overall, FHA loans are good options for borrowers with bad credit and a little money on the side for paying a down payment.
Eligible donors can provide gift funds to the borrower. They can pay 100% of the borrower’s closing costs and down payment. If the property that the homeowner buys is a 1-2 unit property, it requires no reserves. Essentially, the applicant interested in FHA mortgage loans doesn’t need much cash to finance the purchase.
FHA loans come with slightly lower interest rates. Nonetheless, the borrower has to consider the entire payment to determine the more optimal deal. A mortgage insurance is a necessity of the entire payment. Borrowers who get FHA loans must pay upfront and annual mortgage insurance premiums. Both of these premiums are unavoidable. In fact, the upfront mortgage insurance premium doubled from 1% to 1.75% in 2012. The annual mortgage insurance premium, on the other hand, decreased. In effect, FHA loans are still an attractive bet for a homebuyer.
FHA mortgage insurance premiums are difficult to cancel. It is possible to go from an FHA to a conventional refinance. This gives you the option to dump the MIP when you have the necessary home equity. In short, the mortgage insurance premium doesn’t need to stay for life.
FHA loans offer a purchase mortgage as well as refinance loans. With an FHA loan, you can also get a “streamline refinance.” A streamline refinance is a cheaper and quicker way to refinance your loan in a low interest rate period. In other words, you can end up with a 15-30 year fixed mortgage. Another option is to end up with a 5/1 adjustable-rate mortgage. Additionally, the max LTV for a cash out refinance is a very low 85%. Hence, if you’re looking for something a little different, perhaps FHA isn’t the most optimal loan for you.
Offered at Owner-occupant Properties
FHA loans are only available at owner-occupant properties. A non-occupant co-borrower can help you qualify for the loan. Together, you can use blended ratios to help see if you qualify for the loan. Blended ratios are debt-to-income ratios that take into consideration the borrower’s and non-occupant co-borrower’s income and monthly payments. These two payments are blended to see if you meet the qualification.
This government backed program comes with extra paperwork and additional complexities. You can generally have one FHA loan at a time. You can use a plethora of FHA loans to purchase and/or refinance a home loan. Yet, you cannot use FHA loans for second homes or investment properties. Also, FHA loans don’t approve many condominium complexes for financing. Nonetheless, the Jurisdictional HOC can make the exception that they be used for second homes or investment properties.
Interest Rates, Downpayment, Loan Limits, and FICO Score
Conventional loans include both conforming and non-conforming loans. So you can get anything from a 1-month ARM to a 30-year fixed rate mortgage. For example, if you’re looking for a 7-year ARM or a 10-year fixed mortgage, conventional loans are your best bet.
Fannie Mae and Freddie Mac issued new guidelines that allows people to get a conventional loan with a 3% down payment. That’s right! This is lower than the down payment required for FHA loans. Furthermore, the loan limit for conventional loans are higher. In certain parts of the country, your conventional loan can be as high as $679,650. So people living in high-cost regions of the country can save a good amount of money. Anything above the FHA loan limit of $300,000 is considered a jumbo loan. Hence, it’ll be tied to a higher mortgage rate and tougher underwriting criteria such as more limited DTIs and higher down payment requirements. However, in terms of credit scores, FHA offers a better option. Conventional loans require you to have a minimum FICO credit score of 620.
Mortgage Insurance Requirement?
Unlike FHA loans, conventional loans do not subject you to mortgage insurance premiums. This stands if you put 20% down or have at least 20% home equity when refinancing. Even if you can’t, you can qualify for low down payment loan programs. You don’t even have to pay the private mortgage insurance out of pocket under these programs.
Various lenders offer programs in which you can put a 3% down with no mortgage insurance. You can even put less than that without being subject to a mortgage insurance. Needless to say, you can argue that a private mortgage insurance is still implicitly built into the rate when you put less than 20%. Worse comes to worst, you’ll be stuck to pay a high interest rate.
Comparison: FHA Loans vs. Conventional Loans
Unlike FHA loans, you can find conventional loans at every bank and lender in the country. You can’t find FHA mortgage loans everywhere. In that respect, you are limited. In addition, as mentioned earlier, FHA has minimum property standards. So even if you exceed down payment and credit score requirements, some properties are not approved for FHA financing. You may just have to go the conventional loan route. You can use conventional loans to finance any property.
In addition, if you’re trying to get a second home and/or non-owner investment property, you should look into conventional loans. After all, FHA loan programs are only good for owner-occupied properties.
If you are going into anything new, the best bet for you would be to do your personal homework. Look to see what makes sense for you depending on your unique situation. One loan may be more optimal for your scenario than another loan. In addition, make sure your property even meets the respective loan requirements.
With a low credit score and a little set aside for a down payment, an FHA loan will fare better with you. Nonetheless, if you have a higher credit score and more money on the side for a down payment, you can save more with a conventional loan. Both loan programs offer flexible underwriting guidelines, competitive mortgage rates, and competitive closing costs.
You have to pay a mortgage insurance if you get an FHA loan. Still, if you receive a lender credit and/or a lower mortgage rate, FHA loans may be cheaper. Without it, however, go with conventional loans—you’ll avoid mortgage insurance costs. Needless to say, in the short term, FHA loans may serve you better. Yet in the long term, conventional loans will be cheaper. You can drop the PMI and save lots of mula.
At the end of the day, you’ll want to do a side-by-side cost analysis. You can talk to your real estate agent and 3CALoan—your mortgage broker. Yet, you have to make the decision yourself regarding which loan is better for you.