Which Home Financing Option is Better? FHA or Conventional Loan
Find out the ins, outs, pros, and cons of these two popular mortgage financing options.
When you look ahead to your home purchase, you probably think of the search itself as the most important aspect of the process. However, it’s important to remember that while you can always change out a paint color or outdated lighting fixtures, it’s difficult to change your mortgage terms once you’ve signed at the closing table. That’s why it’s vital to determine which type of financing option is right for you.
Two of the most popular home loans are the FHA (Federal Housing Administration) mortgage and the conventional mortgage. They each offer their own unique benefits and features for homeowners with a variety of financing needs and down payment amounts. Learn more about each loan type to determine which one is perfect for your upcoming home purchase.
Conventional Loan vs. FHA Loan
There are a wide variety of conventional loans available with all types of terms and conditions. Conventional loans are available through banks, credit unions, new home builders, and many other lenders. They are private-sector loans that are not insured by any federal agency.
FHA loans are backed by the Federal Housing Administration. They are designed to incentivize lenders to provide mortgage loans to lower-income borrowers and those with lower credit scores. While they are popular with first-time homebuyers, FHA loans are available for any type of home purchase.
Conventional loan vs. FHA loan requirements
Conventional mortgages are private-sector loans, so the requirements are set by the individual lender and generally include, in addition to the down payment, the following:
- Credit score: Most conventional loans require at least a 620 credit score. This requirement can be higher due to certain market conditions or for loans in higher-than-average amounts.
- Debt-to-Income ratio: Most conventional loans require a DTI of less than 50%, with preference given to lower ratios.
FHA loan requirements are set by the Federal Housing Administration and generally include, in addition to the down payment, the following:
- Credit score: FHA credit scores vary with the down payment. Buyers seeking a loan with a 3.5% down payment need a credit score of 580 or higher. Those with a credit score between 500-579 will need to put 10% down.
- Debt-to-Income ratio: FHA loans require a DTI of less than 50%.
Conventional loan vs. FHA loan limits
For 2021, the conventional (conforming) loan limit is $548,250 throughout most of the United States. Larger loans are called “jumbo loans” and are subject to limits set by the individual lender. Jumbo loans generally have more stringent approval requirements including larger down payments and higher credit scores.
For 2021, the FHA loan limit in many areas is $356,362 with higher limits of up to $822,375 in some high-cost housing markets. These loan limits vary by county and can be adjusted annually.
Conventional loan vs. FHA loan down payment
While you may think of the traditional 20% down payment when you hear “conventional mortgage,” conventional loans feature a range of down payment options from 3-20%. FHA mortgage down payments range from 3.5% (for borrowers with credit scores of 580 or higher) to 10% (for borrowers with credit scores of 500-579).
Conventional loans and PMI (Private Mortgage Insurance) vs. FHA and PMI
For homes with less than 20% equity, conventional lenders require private mortgage insurance to provide additional protection from default. If you put 20% down, you won’t have to pay PMI at all. If you put less than 20% down, you will need to pay PMI either upfront or in a prorated amount as part of your mortgage payment each month.
Once you have accrued 20% equity in your home, you can contact your lender to remove PMI from your monthly payment. If you reach 20% equity because of a change in market conditions, your lender will need a new appraisal in order to remove the PMI requirement.
No matter how much you put down on your FHA loan you will be required to maintain private mortgage insurance. Once you reach 20% equity in your home, you will need to refinance into a conventional mortgage in order to stop paying PMI.
Conventional loan vs. FHA loan appraisals
Conventional loan appraisals are designed to reassure the lender that the house you are buying is worth the amount of money you are borrowing. They look at the fair market value of the home based on its location, size, features, and comparable recent home sales.
FHA appraisals look at all of the same aspects as conventional loans to determine the market value of the property you are purchasing. In addition, however, FHA appraisers are required to determine whether the home meets minimum property standards for safety, security, and soundness.
How do I know which loan is better for me?
Talking with your lender is the best way to determine which type of loan is best for you. He or she can run the numbers on both types of mortgage products to determine which is the right fit.
An FHA loan may be a better option if you have a lower credit score or are not sure whether you’ll qualify for a conventional mortgage. If your credit score is 620 or higher, a conventional mortgage may offer a slightly lower down payment and has the advantage of PMI that drops off once the 20% equity threshold has been met. In addition, if you are buying a fixer-upper, a conventional mortgage will not need to meet the minimum property standard required by the FHA loan.
Are you searching for a new home in Tampa or Wesley Chapel, Florida? Do you have a home in Tampa that you’re thinking about listing? Are you ready to upsize, downsize, or right-size your Florida home? Contact us to find out more about real estate in Tampa and all of the ways we can help you make your goals a reality.