FHA vs Conventional Loans

Certified Mortgage Advisor
NMLS 1701021
Published 
July 19, 2019

FHA or Conventional loan, which one is better?

Let's talk about FHA versus conventional loans. You're going to learn which is going to be the best loan for you, and which loan might save you the most amount of money possible. And then a strategy that I use with a lot of clients to help them make sure that they get the down payment and the rate that they want front, and then have the best long-term savings over the life of the loan.

Which loan to choose?

So let's dive in when you are shopping for a mortgage. You're gonna run into a lot of different options with a home loan. One of the biggest options that people face is are they going to go with an FHA loan or will they go with a conventional loan? And there are a couple of different nuances here on the differences between the two that will help you make a better decision. Which one is right for you.

FHA credit score

So right off the bat FHA loans normally have a floor of a 580 credit score. So FHA loans are better for people with lower to middle credit scores. Whereas when you get a higher credit score, conventional is usually going to be the best loan for you.

And what I mean by the best loan here is what's going to give you the most savings. If you take a conventional loan with a lower-end or a mid-end credit score, then you're going to have a lot higher rate on the conventional loan than you would with an FHA loan because FHA loans are suited more towards low credit to mid-credit.

Conventional credit score

Whereas conventional loans, normally around that 680 range, you're gonna start seeing a lot better interest rates.

Down payment

Also on the FHA, you have a 3.5% minimum down payment. So if it's a hundred thousand dollars house, you have to put $3,500 down on that property. On conventional loans. Sometimes you can get 3% down, sometimes there are income limits, or you have to be a first-time home buyer. But most of the time that down payment is actually 5%. So if the 5% down is too much, you can flip over to the FHA loan to get that three and a half percent down and save you some money at closing.

FHA is forgiving to credit events

Also, FHA is going to be more accommodating for people with bankruptcies, foreclosures, sheriff sales basically any negative credit event, FHA loans have a shorter time period that you have to wait outside of those dates.

Strict with credit events and needs to wait longer

Whereas a conventional loan. Is going to require you to wait a lot longer, sometimes double or triple the amount of time in what's called seasoning. Before you can get a loan like that. So if you have a negative credit event it might be worth exploring an FHA option first and then refinancing into a conventional loan.

FHA as primary residences

Also, FHA loans are only for primary residences. So if you're getting an FHA loan, it cannot be an investment property. You have to reside in the property to get an FHA loan.

Conventional can be an investment or a second home

Whereas a conventional loan can be an investment. It can be a primary residence. It can be a second home. Those occupancy options are a lot more flexible than the conventional.

FHA allows higher debt-to-income

FHA is also gonna be more accommodating if you have a lot of debt. So a lot of high, monthly debt obligations, FHA might be a better option for you. Usually you can get the debt-to-income ratio on an FHA loan to go up to 55, 56%.

Conventional prefers lower debt-to-income

Whereas a conventional loan, their debt-to-income ratio normally is gonna tops out around 49%. Sometimes even lower depending on your credit score.

6% Seller concessions for FHA

FHA will allow you to ask for 6% of the purchase price in seller credits. So the money that you're getting from the seller to pay down closing costs.

3% Seller concessions for Conventional

On the conventional side, normally it's 3%, depending on how much money you put down, though, this can change and go all the way up to 9%. So talk with your mortgage advisor on what some, what are options you have there with seller credits? Most of the time, I've never seen anybody ask for over a 6% seller concession. Just because normally you don't need that much.

Why is FHA more expensive?!

Also, FHA mortgage insurance is a lot more expensive than on the conventional side. So FHA, you have two types of mortgage insurance that are going to be on every loan.

Upfront mortgage premium

So you're gonna get charged an upfront mortgage insurance premium. This is normally wrapped into the loan, but it's about 1.75% of the loan. So if you're taking a hundred thousand dollars loan, you're gonna get charged in extra $1,750 added to your loan, and that goes to FHA.

Not only that you pay the upfront plus you'll pay monthly mortgage insurance.

No need to pay mortgage insurance on conventional

On the conventional side, you pay no upfront mortgage insurance, but you do pay monthly mortgage insurance. If you have equity below 20%. So if on a conventional loan, you only put 5% down. You're going to have to wait until you build up 20% equity in the property for your mortgage insurance to fall off.

FHA mortgage insurance will stay on your loan

On the FHA side, that mortgage insurance is going to stay on your loan for the life of it. Unless you put more money down. Usually starts at about 10% before that mortgage insurance is gonna fall off after about 10 years. And then finally, the bottom line is the main difference between his loans. FHA loans are a lot easier to qualify for. They're gonna allow you to have more debt, and lower credit scores and they're gonna be more lenient on helping you qualify.

Conventional loans though, are going to help you save more money over time. If you're well qualified for them. So the issue that people run into is they see how conventional loans are usually better for them, but maybe they don't qualify for the conventional or in their circumstances.

Conventional might be more expensive

For instance, sometimes when I talk with people who have lower credit scores and we compare FHA versus conventional, the conventional loan is actually more expensive over a period of time because they're getting charged at an incredibly high rate because of their credit score.

FHA can be a stepping stone to a conventional

So you can think of an FHA loan as a stepping stone to getting into a conventional. So if right now, if FHA loan is the best option for you, or it's the only one that you qualify for, what you can do is talk with your mortgage advisor and see, okay, what do we need to fix to make sure that we can get a conventional loan and we can refinance in the future, right? Because when you get a loan, you don't have to hold onto it for 30 years or 15 years or however long, your term is.

Improve your numbers and refinance

You can refinance when rates change or if your circumstances in life change. So if your credit score right now is a little on the lower end and you get an FHA loan, that's gonna help you secure that property, build equity maybe you're stopping paying rent. Get some appreciation for that property. And then as you're working to build up your credit score, maybe in two to three years, you refinance into a conventional loan. Then you save yourself on mortgage insurance and rate and overall cost and get better savings on the conventional side.

So hopefully this helps you clear up some ideas and get a better understanding of FHA versus conventional. Keep in mind, that you don't have to have these loans over the entire term. You can always refinance and get into a better loan if circumstances change.

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