FHA vs. Conventional Mortgage: Pros and Cons

Are you trying to decide between an FHA and a conventional mortgage for your home loan?

The easy answer is to find the loan that best fits your particular situation and needs! Here’s information to help you with the pros and cons of FHA loans and conventional mortgages. We’ve also included a comparison chart between the two types of loans at the end of the blog.

FHA Loan

FHA loans are mortgages insured by the U.S. government’s Federal Housing Administration. The insurance allows lenders to offer qualifying terms that are less strict than conventional mortgages. That means that homebuyers (particularly first-time buyers) can more easily qualify for a mortgage. FHA loan terms include:

• Low down payments
• Low closing costs
• Easy credit qualifying

FHA loans were designed to help lower- to middle-income buyers become homeowners, so there is a limit on loan amounts (depending on location). A loan also comes with some other conditions. For example, 2021 FHA rules require homeowners with certain loans to purchase mortgage insurance (MIP), which protects lenders against a loan default (nonpayment).

Here’s a short video about how FHA loans work.

FHA Loan Eligibility Requirements

Here are 2021 FHA loan eligibility requirements you have to meet to get an FHA loan, as summarized by the money advice website Nerdwallet.com:

• Credit score of at least 500
• Debt-to-income ratio of 50% or less (what you owe compared to how much you earn)
• 3.5% down payment if your credit score is 580 or higher
• 10% down payment if your credit score is 500-579
• The house must be your primary residence and meet FHA’s property requirements

Remember that FHA insures loans for the lender. You still have to work with an FHA approved lender to qualify for a home loan.

FHA Loan: Pros

Here are some distinct FHA home loan advantages:

• Low down payments of as little as 3.5% of the home’s purchase price
• Low closing costs
• Buyer minimum credit scores that are lower than required by conventional mortgages
• Higher debt-to-income ratio than allowed by conventional mortgages

FHA Loan: Cons

Here are some FHA home loan disadvantages:

• An extra cost – an upfront mortgage insurance premium (MIP) of 2.25% of the loan’s value. The MIP must either be paid in cash when you get the loan or rolled into the life of the loan.
• Home price qualifying maximums are set by FHA
• Interest rates are higher than with conventional loans (based on relaxed borrower eligibility requirements)

An FHA loan calculator can help you estimate your monthly payments and decide your next steps.

Conventional Mortgage

Conventional mortgages are established financial vehicles for purchasing a home with a down payment and an amortized home loan (reducing the loan with regular payments over time).

Conventional loans are held by groups such as banks, credit unions, and savings and loan associations. Homebuyers can get a loan from any one of these institutions or work with a mortgage broker that writes the loan and funds it initially before selling it to another institution.

Traditionally, getting a conventional mortgage meant paying 20% of the home price as a down payment and borrowing the rest in a 30-year mortgage. Conventional mortgages are now much more flexible, and lenders can sometimes give you a mortgage that requires a 10% or less down payment with varied loan lengths and terms. There are many types of conventional loans and they can’t all be described here.

However, 20% down gives buyers quite a lot of skin in the game – a sizable amount of home equity that makes it far less likely they will default on mortgage payments. That gives buyers an advantage with lenders for getting low interest rates and favorable loan terms. And lenders may require borrowers who pay less than 20% down to have private mortgage insurance (PMI) to protect the lenders’ investment.

Conventional mortgages are not backed by the government the way FHA loans are, so private mortgage holders protect their investments with stricter eligibility requirements than FHA loans.

Conventional Loan Eligibility Requirements

These conventional loan eligibility requirements are a basic guide. You can read more here.

• Credit score of at least 620. Borrowers with a score of 740 or more get the best loan terms.
• Debt-to-income ratio below 36% (total monthly debt/payments – car, credit cards, rent/mortgage, etc. – divided by monthly pre-tax earnings)
• Proof of cash available for a down payment

Conventional Loan: Pros

• Flexibility on loan terms
• No home price maximums with a nonconforming home loan
• No PMI with a 20% or greater down payment

Conventional Loan: Cons

• Higher credit-score threshold and lower debt-to-income ratio to meet than with FHA loan
• PMI insurance with < 20% down payment
• Meeting strict eligibility requirements overall

A conventional mortgage calculator can help you understand the total cost of your loan and your monthly payments.

Compare FHA Loan and Conventional Home Loans

Compare an FHA loan and conventional mortgages. Then see which loan is the better fit for your particular circumstances and financial situation right now.

 

	FHA Loans	Conventional Mortgages
Minimum credit score	As low as 500	No lower than 620
Debt-to-income ratio	50% or less	<36%
Minimum down payment	As low as 3.5%	5%-20% is typical (but as low as 3%)
Upfront costs	Mortgage Insurance Premium (MIP) of 2.25% of the loan’s value, which can’t be cancelled	Private Mortgage Insurance (PMI) with <20% down payment, which can be cancelled when borrower’s ownership reaches 80% equity (loan-to-value ratio)

Make a Final Decision: FHA or Conventional Mortgage

You’ve done your homework and learned the difference between FHA loans and conventional mortgages. Take the next step and work with a loan officer who asks the right questions – like the knowledgeable, experienced ones at Capital Bank – and can find the loan that fits you best. Then you’ll have everything you need to make your final decision!