Conventional Loan vs FHA
When you apply for a loan, lenders will assess your financial situation and let you know what kind of mortgage you qualify for. The majority of mortgages are conventional loans but some are backed by the Federal Housing Agency (FHA). Both mortgages are designed for the purchasing of property, but there are a number of key differences between them.
Learning more about an FHA vs conventional loans can help borrowers make more informed decisions when applying for a mortgage. FHA loans are backed by the federal government but they are not issued by the FHA. Instead, they are granted by FHA-approved lenders.
The purpose of FHA loans is to help low-income families and people that struggle to attain financing so they are still able to purchase a house. People may have difficulty buying a house because their credit score is not high enough, they have large outstanding debts, or they are unable to save up a large down payment. Usually, people in this situation are more likely to get an FHA-backed loan than a conventional one.
However, if somebody has a good credit score and they are in a stable financial position, it will usually be easier for them to get a conventional loan. These will be offered by private lenders like banks or credit unions. They are not backed by the federal government and the requirements that borrowers must meet to qualify for them are stricter, in most cases.
Key Points
Conventional mortgages are usually aimed at people with good credit scores and low levels of debt.
FHA-backed mortgages are designed to help people in a less stable financial position that want to buy a home.
Most FHA loans have lower credit score requirements and smaller down payments, though this is not always the case.
Conventional loans are not backed by the FHA and are offered by quasi government/private companies. (quasi Fannie/Freddie)
FHA Loans
FHA (Federal Housing Agency) loans are backed by the federal government, also known as Ginnie Mae, or Government National Mortgage Association. This means that if the borrower defaults on the loan because they are unable to make the monthly payments, the government will pay the lender. This is much safer for the lender because they are not at risk of losing out if the borrower defaults. As a result, they are willing to take more risks and the terms for qualifying are not as stringent. In many cases, the interest rates on FHA loans could be favorable for the borrower. Also note that properties in areas such as Key West and Miami may have higher loan amount thresholds as well.
All of this means that people in a difficult financial situation can still access funding for buying a home. You can borrow the majority of the value of a home with an FHA loan (usually more than you can borrow with a conventional mortgage). So, the percentage that you need to save as a down payment is much lower and more accessible to low-income individuals and families. Those with very low credit scores should still be able to get an FHA-approved but, in some cases, the down payment may be larger.
The closing costs often differ with FHA-approved mortgages. In some cases, there are additional closing costs that need to be paid that wouldn’t normally apply with conventional loans. However, even with these extra closing costs, an FHA loan is still more favorable for low-income borrowers.
There are differences between conventional vs FHA loans where mortgage insurance is concerned too. With conventional, mortgage insurance is not required if the down payment is above a certain percentage of the value of the property. It will not be automatically removed but if you speak to your lender, they may be able to cancel the mortgage insurance requirement. However, FHA loans do require mortgage insurance and this can be paid in two different ways. In some cases, it will be rolled into the cost of the loan and paid over a certain number of years. Alternatively, the borrower can make separate monthly payments for their mortgage insurance.
What Can FHA Loans Be Used For?
When comparing FHA vs conventional, there may be differences in terms of what the loans can be used for. FHA can be used to buy single-family properties as well as multi-family properties, but only as long as they have a maximum of four units. Condominiums can also be purchased using an FHA loan. In some cases, borrowers can get an FHA for manufactured homes and mobile homes. However, this only applies to certain types of homes, so it won’t necessarily be an option with every lender.
FHA is also available for refinancing homes and there are specific types of FHA that are designed for building a new home. You may also be able to get an FHA mortgage for making renovations on your home.
Before an FHA mortgage is approved, the lender may require inspections to be carried out on the property. If there are issues with the home and repairs that need to be made, somebody may have to pay to fix these problems before the mortgage is approved. It will be negotiated between the buyer and the seller who is responsible for covering these costs.
Conventional Loans
The main difference with a conventional loan vs FHA is that conventional is not backed by the government. This means that the financial institution that originates the loan takes on all of the risks. If the borrower is unable to pay, the lender may potentially lose money. Mortgage insurance is used to protect the lender, in some cases.
Due to the increased risk taken on by the lender, it is often more difficult to qualify for a conventional. During the application process, the lenders will assess your finances based on a number of different factors and then make a decision about whether you qualify for the mortgage, how much you are able to borrow, and what the interest rate will be. Credit scores are one of the most important deciding factors. In most cases, the credit score requirements will be higher than they are for an FHA loan. The percentage of the value of the property that you are able to borrow is usually lower too, which means that borrowers must save a larger down payment before they qualify for a conventional loan.
Interest rates vary depending on the lender that you go with, the type of debt, the current market conditions, and the amount of the down payment. Although interest rates on FHA loans tend to be lower, there are options for conventional loans with a lower interest rate as it all depends on a variety of factors.
Conventional mortgages are divided into two main categories called conforming and non-conforming loans. This refers to whether the loan conforms to lending standards set out by Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation). These are both government-sponsored agencies that buy home loans that are originated by lenders. They purchase around half of all loans originated in the US, so many lenders will create mortgages that conform to these standards. However, Freddie Mac and Fannie Mae loans are not the same as FHA loans. Although these organizations have ties to the federal government, they are not directly managed by the government, they are known as ‘quasi government’.
Both Fannie Mae and Freddie Mac aim to stabilize the mortgage market by providing capital and making more money available for residential mortgages. As a result, borrowers have access to more mortgage products. Fannie Mae and Freddie Mac are also involved in schemes to help low-income borrowers get mortgages, but these are separate from FHA-approved loans. This means that there are conventional mortgage options for people with a less favorable credit score or a small down payment.
What Can Conventional Loans Be Used For?
Another key difference between FHA vs conventional loans is that borrowers have more freedom over what they are used for. With FHA loans, the borrower must spend the money on their principal property, meaning that they live there the majority of the time. However, conventional loans can be used for many different types of property.
Conventional can be used to buy a principal residence just like an FHA loan. However, they can also be used to buy second properties like vacation homes or investment properties too, which is not an option with FHA loans.
Refinancing Loans
Refinancing is an option that people take if they can get a more favorable interest rate or terms, change the terms of the mortgage and pay it back faster, or if they want to release equity from their home. But how does refinancing work with conventional vs FHA loans?
In most cases, refinancing is an option with both conventional and FHA loans. When refinancing your mortgage, you take out a new mortgage and use that to pay off the existing one, meaning that you only pay one monthly payment for the new mortgage. This can benefit borrowers in a lot of situations, but you will always have to meet the requirements for the new mortgage.
For many people, this means that they will not be able to refinance their FHA mortgage with a conventional one because they do not qualify. However, if borrowers are able to improve their financial situation and meet the requirements, they can refinance their FHA for a conventional loan. This means that they may be able to borrow more money.
The Bottom Line
The main differences between FHA vs conventional loans is that FHA is backed and secured by the government while conventional are not. This means that lenders offering conventional absorb more risks, meaning that the requirements to qualify for these mortgages tend to be higher. However, the interest rates and limits vary depending on many factors, so there may be options for low-income earners that want conventional too.
FHA loans are well suited to low-income borrowers, but they are not limited to people that are facing financial hurdles. Anybody can apply for an FHA but some people may be put off by the limits on the amount that can be borrowed.
Alternative Government-Backed Mortgages
FHA loans are not the only type of government-backed mortgage available. Depending on their situation, borrowers may also qualify for other types of home mortgage that are supported by the government.
VA (Veterans Affairs) loans are backed by the US Department of Veterans Affairs. These mortgages do not require a downpayment and, in most cases, do not charge mortgage insurance. Borrowers must be a qualified member of the armed services, a spouse of somebody in the armed services, or another beneficiary to qualify for these mortgages.
USDA (US Department of Agriculture) backed mortgages are specifically designed for purchasing properties in rural areas. They also don’t require down payments, in most cases, and they are more flexible in terms of the credit score requirements. These loans are aimed at rural areas such as Wauchula.
Hiring A Mortgage Broker
Some borrowers decide to make their own comparisons of conventional vs FHA home loans so they can determine what is best for their situation. However, hiring a mortgage broker, such as MortgageQuote.com, can make the process much easier for homebuyers. Knowledgeable mortgage brokers will have access to many lenders and they can help buyers find the right loan for them, whether it is an FHA or conventional mortgage.
At Mortgage Quote, we are a one stop shop that can help you simplify the mortgage application process and do all of the hard work for you. We have programs for both conventional and FHA, so regardless of your financial situation, we can find the perfect mortgage for you. If you need any more information about the different types of mortgages available to you, our mortgage education resources center can help you. Alternatively, get in touch and talk to us about your mortgage goals. We can discuss some of the many ways we can help you with your loan, so you can get your home buying journey started as soon as possible.