FHA or Conventional Loan
In the world of home loans, much like many other things, there are several options for borrowers. When someone wishes to buy an automobile, there are multiple choices to make from new or used, function or need, and paying cash or financing. For home buyers, two of the most popular types of home loans are the FHA and conventional Fannie Mae mortgages. The following assessment of an FHA vs conventional mortgage will allow readers to make the best choice for their needs.
General Comparisons of FHA and Conventional Loans
People that qualify for a Fannie Mae loan typically have higher credit scores. Conversely, people with only average scores, or slightly lower than average, are routinely qualified for an FHA loan.
Each lender will have its own rules about which credit score they will accept for both types of loans. Check with your local lender to ask about their credit score minimums for different loans.
When refinancing conventional loans, borrowers go through the same process as if they were buying the home for the first time. Borrowers will need to document their income, have their credit pulled, get a new appraisal of the home, and possibly document their home address for the past 2 years.
In contrast, FHA offers a streamlined option. Borrowers do not have to request a new credit score, income does not always have to be documented and most of the time a new appraisal will not be required.
Maximum Loan Amount
FHA has varying loan limits. The limits vary from state to state and even from county to county within the same state. However, generally speaking, the maximum FHA loan amount is much lower than the maximum conventional loan amount. This is true even in high-cost areas like Hawaii, New York, and California.
In order to qualify for FHA, the borrower must intend to live in the home as their primary residence. There are no exceptions to this rule. In addition, the borrower must move into the home within 60 days of signing the documents to purchase the property.
For conventional programs, borrowers may use the home as their main residence or as an investment property, or as a second home. As long as the person(s) qualify for the loan, there are no restrictions on how the property is used.
There are several differences between the two programs in the area of down payment. First, FHA only requires as little as 3.5% for the down payment. Conventional loans may require a 3-5% down payment, or it may require as much as 20% down depending on various factors.
There are a few down payment assistance programs available throughout the country for qualified borrowers. However, these programs can only be used for an FHA purchase. Conventional financing requires the down payment money to come from the borrower’s own funds.
In addition to the down payment assistance programs, FHA will also allow a relative to gift the down payment money to the borrower. Conventional loans will allow only a portion of the down payment to come in the form of a gift.
If a borrower finances more than 80% of the home’s value, they will pay monthly private mortgage insurance (PMI) with a conventional and FHA.
However, the FHA loan will require an additional upfront mortgage insurance premium that will not be required by a conventional program.
In addition, once the balance drops below 80% of the home’s value, conventional loans will stop charging the monthly PMI. However, FHA loans will charge monthly mortgage insurance for the life of the loan.
Status of the Previous Owner
There is one restriction that is exclusive to FHA loans. FHA guidelines state that the program cannot be used to buy a flipped property. A flipped property is real estate bought by an investor for the sole purpose of reselling it in a short amount of time. The current rule states that FHA loans cannot be used for the purchase of a home if the current owner of the home purchased the property within the last 90 days.
Conventional loans do not have this waiting period requirement.
When to Choose Conventional
There are some basic ways to determine why a person should choose conventional financing over FHA. Here are some quick qualifications to help make a choice.
- The borrower has a higher credit score
- The borrower is planning to buy a home priced higher than $356,362 (for most places)
- The borrower is able to pay 3-5% or more as a down payment
- A high debt to income ratio (FHA only allows 43%)
If you meet more than 2 of these conditions, you should really consider using a conventional program for your purchase. For people that plan to pay at least 20% down on a new home, a conventional program is almost always the best choice. FHA now requires PMI on all of their loans for the duration of the mortgage. People that make a large down payment would simply be paying for PMI for no reason.
Shortcomings of a Conventional Loan
As stated at the beginning of the article, this was not intended to prove that one type of loan is better than another. Merely a comparison to indicate why people would use one loan in one situation and another loan in a different situation. Since neither loan is perfect, we need to be alert to some of the drawbacks of using a conventional financing for a home purchase.
- Most borrowers will need reserve funds. This is extra money, above the down payment and closing costs, that is liquid. Some borrowers may only need an amount equal to 2 months of the proposed mortgage payment. Others may need as much as 6 months
- Qualifying for conventional loans is more stringent. There is a reason why FHA is so popular as a way to buy a home. The ability to qualify for an FHA mortgage is much easier than a conventional loan.
- A significantly higher credit score is needed compared to FHA or other types of loans
This is one reason why so many people choose to work with a lender that can offer both options. The lender can review the borrower’s credit score and income documents and provide the borrower with their projected payments, and chances of approval, for both loans.
When to Choose an FHA Loan
There are a few basic ways for a person to decide if an FHA loan is a good option for them.
- The borrower only has an average credit score, or possibly slightly below average
- The borrower only has enough money for a 3% down payment or can obtain a down payment from a relative
- The borrower does not have any reserves
- The borrower needs a non-occupying co-borrower
Any person that meets at least one of these requirements should take a serious look at using the FHA loan program for their home purchase. Although there may be a bit more paperwork involved, it will likely be the easiest scenario for homeownership.
Shortcomings of an FHA Loan
Just as the conventional mortgage is not perfect in every way, so too the FHA loan has its drawbacks.
- Any borrower that pays below a 10% down payment will be required to pay Mortgage Insurance Premiums monthly for the duration of the loan
- The upfront mortgage insurance payment will be required on all loans, even if the borrower is making a 20% down payment
- The maximum loan amount is lower than a conventional loan in the same state or county
Going over your specific financial needs and goals with your lender is the best way to determine if the FHA loan is a good fit for you.
Summing Up FHA or Conventional Financing
Both the conventional mortgage and FHA mortgage have helped thousands of borrowers obtain the status of homeownership. There is no right or wrong loan for every borrower. Conducting a self-audit on your finances, and consulting with a reputable lender, should lead you to make the best choice for your needs at that particular point in time.
Additional FHA and Conventional Program Resources:
FHA Loan Quirks by Anita Clark
25 First Time Home Buyer Tips by Eric Jeanette
First Time Home Buyer Mortgage Tips by Bill Gassett
Is An FHA Program Right For You by Kevin Vitali
Home Loan Down Payment Requirements by Glenn Shelhamer
About the author: This article on “FHA or Conforming Mortgages” was written by Luke Skar of MadisonMortgageGuys.com. As the Social Media Strategist, his role is to provide original content for all of their social media profiles as well as generating new leads from his website.
We provide award winning customer service to clients who need to purchase a home or refinance an existing mortgage. Our branch currently serves Wisconsin, Illinois, Minnesota and Florida. On our website you will find state specific mortgage program information for all states including information on VA loans. For example, take a look at our FHA Loan page for Minnesota.