Conventional or FHA Loan: What’s the Big Difference?

In today’s marketplace, the two most common mortgage programs are Federal Housing Administration (FHA) loans or Conventional loans. What’s the difference and how are you supposed to know which is best for you?

For a homeowner, the main differences between an FHA and a Conventional loan are costs, qualifications, and program guidelines.

FHA loans
When your mortgage analyst talks about an FHA loan, he or she isn’t talking about getting a loan from the government as the FHA doesn’t actually originate loans. Rather, the FHA insures loans made by FHA-approved lenders, thus protecting them against default. FHA loans are generally best suited for those consumers looking to purchase a home with a lower down payment or those with lower credit scores.

Conventional loans
Lending institutions offer various types of conventional mortgages products to help address the many different financial needs of current and potential homeowners. These loans are often purchased by government agencies like Fannie Mae or Freddie Mac on the secondary market after the loans are closed and funded by banks and lending institutions.

Program differences
Here are a few key differences between FHA and Conventional loans broken out by category:

• Down payments
  FHA loans usually require a lower down payment, as little as 3.5 percent of the purchase price. Conversely, Conventional loans require up to 20 percent down to avoid payng private mortgage insurance (discussed below). Some conventional loan programs allow down payments as low as 5 percent depending on the type of home you’re buying and your credit score.
• Qualifications
  For Conventional loans, borrower qualification is largely based on the credit score. While loan qualifications became stricter between 2007-2011, more recent programs have allowed for scores as low as 620.
   
  FHA programs allow lenders to use a broader range of information to make approval decisions. For instance, Reliance First Capital can offer loans to borrowers with scores as low as 560 (restrictions apply). Debt to Income Ratios (the amount of your monthly payments compared to your monthly income) can generally be higher on FHA loans than Conventional loans.
• Loan limits
  Both Conventional and FHA loans have lending limits determined by the county in which the property is located. While Conventional loan limits start at $417,000, FHA loans have certain counties where the maximum loan amount is as low as $271,050.
   
  There are also High Cost Counties which can allow for up to $625,500 Conventional loans and $729,750 FHA loans. Check with your lender to find out what your county loan limit is so you can plan your purchase or refinance accordingly.
• Mortgage insurance
  For conventional loans where the LTV (loan-to-value; loan amount divided by appraised value/purchase price) is greater than 80 percent, you are required to pay private mortgage insurance (PMI) as either a one-time upfront payment or on a monthly basis until your LTV ratio decreases to less than 80 percent. The ratio changes as you pay down the loan or your home’s value increases.
   
  FHA loans require mortgage insurance on all loans. There is both an upfront mortgage insurance premium and then a monthly premium which is added to the monthly mortgage payment. For loans with terms greater than 15 years, insurance premiums are paid for at least the first five years of the loan and then until the LTV reaches 78 percent or less. For loans with terms 15 years or less, the insurance premium is paid until the LTV reaches 78 percent or less.

Understanding the various loan programs available and their benefits is a key step in the mortgage process. At Reliance First Capital, our Mortgage Analysts will provide you with information and answers and customize a loan product that best meets your financial goals.