FHA Loans vs. Conventional Loans

Many Americans struggle between FHA vs conventional loan choices when it is time to buy a house. Both mortgages make it possible for homebuyers to secure the funds necessary to make a large purchase, such as a house, apartment or condominium. A mortgage is a loan provided by a bank or another creditor to a potential homebuyer to help finance the purchase of a home. In return for providing the money up front, the bank or creditor collects interest on the loan.

The FHA loan vs conventional loan debate has been raging for years. Both mortgages have their advantages and disadvantages, and both are designed to help buyers prepare for responsible homeownership. It is important for buyers to understand the differences between these loan types, in order to stay in control of their finances. For more information about FHA and conventional loans, continue reading the topics discussed below.

Funding

It is important to secure either an FHA or conventional loan which is better than trying to pay for a house upfront. Most buyers do not readily have the funds to pay for the entire cost of a home outright. A mortgage makes it possible for buyers to finance the purchase of a house over a set amount of years.

These loan types are funded differently. FHA loans are self-funded entities, which means that the money distributed by lenders comes from other homebuyers who participate in the program. They are also insured by the Federal Housing Administration (FHA), the largest insurer in the world. This protects lenders in the event that a borrower stops making payments and defaults.

When comparing FHA to conventional loan options, on the other hand, conventional loans are not backed by any government entity. Private lenders, servicers and banks offer these types of mortgages. Since these loans are not insured by the government, there are generally stricter guidelines for borrowers.

Borrowing Terms

When deciding between an FHA or conventional loan, one must consider the borrowing term. The borrowing term is the exact amount of time a buyer has to repay the total loan amount, plus any interest. Generally, the borrowing terms for FHA loans are not as flexible as conventional loans. Buyers must usually choose between two types of loan terms. Their choice depends on their down payment and rate of interest for which they qualify.

Borrowers of conventional loans have a few more options in terms of the borrowing term. Lenders and loan services offering conventional loans vs FHA loans have more freedom in determining the loan terms they offer. It is not unusual for a borrower to choose between several loan-term options during the application process.

Down Payments

If you are choosing between FHA vs conventional loan options, it is important to understand the differences in the down payment requirement. A down payment is a certain amount of money you must pay to the lender before the loan is generated. The specific amount of the down payment is a percentage of the total purchase price of the home.

Generally, FHA loans are known for having more relaxed requirements. However, you still must make a down payment to qualify. Whereas conventional loans may require a down payment of 20 percent, FHA loan down payments can be as low as 3.5 percent. However, not everyone qualifies for the lowest down payment option.

Avoid fussing with an FHA vs. conventional loan calculator; simply download our comprehensive guide to find everything you need to know about down payment percentages, mortgage insurance premiums and borrowing term options.

Mortgage Insurance Premiums (MIPs)

One big difference between FHA and conventional loan mortgages is the insurance requirements. Mortgage insurance premiums (MIP) are required for all FHA borrowers, as this payment helps protect the lender, in the event the borrower defaults on the loan. An MIP generally lasts for the entire duration of the loan. This type of insurance lowers the overall cost of the down payment, which is one incentive to acquire an FHA loan.

Borrowers who apply for conventional loans vs FHA loans must also usually pay insurance. Unlike an MIP, private mortgage insurance (PMI) is not always required. For example, borrowers who make down payments of at least 20 percent may be exempt from paying PMI on a monthly basis. Furthermore, borrowers may stop paying PMI once they have equity or once their loan-to-value ratio (LTV) hits a certain percentage. Find everything you need to know about the insurance requirements by downloading our informative guide.

Other Requirements

If you are still wondering, “Should I get an FHA or conventional loan?” it is important to understand some of the other requirements of each to see which type of loan is best for you. For example, if your monthly debts are rather high, you may not qualify for a conventional loan. Lenders examine your debt-to-income ratio, or DTI, to determine if you can afford the monthly payments of your mortgage. If your DTI ratio is high, you may still learn how to qualify for an FHA loan successfully.

The loan limits for an FHA loan vs conventional loan also vary slightly. Each type of mortgage sets limits on the total purchase price of a home, but the FHA loan limits tend to be lower than conventional mortgage limits. These limits also depend on the area in which the home is situated. While the FHA loan may be widely considered a loan for low-income borrowers, this misconception is broken after viewing the loan limits. For example, FHA loan limits in low-cost areas for single-family houses can be as high as $300,000.

When examining FHA vs. conventional loan types, are also certain restrictions on the types of property you can purchase with each loan. FHA loans are only approved for the purchase of owner-occupied properties, which generally exclude vacation homes and multi-unit properties. However, conventional loans have more flexibility when it comes to property type.

Furthermore, before receiving an FHA loan vs. conventional, a borrower must have the property appraised to ensure it meets the safety and loan limit guidelines. During the inspection, an appraiser determines the current market value of the home and homes in the immediate area. He or she also examines the property for damages.

If the house does not meet the standard guidelines, the borrower must typically pay for repairs before receiving the loan. These restrictions may be better understood by viewing an FHA vs conventional comparison chart, which generally includes visual aids to help borrowers fully understand each loan type.


What Are FHA Loans?

The Federal Housing Authority (FHA) insures mortgages and approved lenders to offer mortgages to eligible borrowers. Although available to all home buyers, the requirements of the loan make it attractive for first-time buyers. FHA-approved mortgages typically allow buyers to provide a smaller down payment and apply with a lower credit score than standard home loans. FHA loans covers many needs, including energy efficiency repairs and mobile home financing. Find out about FHA loan benefits in our guide.

Who Is Eligible For An FHA Loan?

If you are interested in getting a home loan through an FHA-approved lender, you must meet program requirements. The most important factor is choosing a mortgage provider approved by the FHA. Employment history is another crucial eligibility factor, as lenders will require proof of employment for the previous two years. Lenders will review your potential expenses, lending histories and your current debts to determine if you can pay your mortgage. Find out more about FHA loan eligibility by downloading our guide today.