Looking for a home loan? Here’s a breakdown of two of the most popular mortgage programs.
The time is right, and you’re ready to buy a house—the first step: Figuring out the differences between the various loan types available. Luckily, we’re here to help you through your homework.
Below, we’ll dive into two of the most popular home loan options, FHA vs. Conventional, explain their key features, and break out a couple scenarios so you can learn which might work best for you.
What is an FHA Loan?
An FHA loan is a mortgage that’s insured by the Federal Housing Administration. FHA loans are available to borrowers of all kinds, from first-time home buyers to homeowners looking to refinance. FHA loans are often popular with first-time home buyers because they allow low down payments. For instance, you can put down as little as 3.5% for a fixed-rate FHA loan if your FICO score is high enough. It’s important to remember that the lower your credit score is, the higher your interest rate will be.
A few other things to consider about FHA loans:
- An FHA loan can be used to purchase a primary residence.
- You can put down as little as 3.5% for a fixed-rate loan. Even if you don’t meet the credit score to qualify for the 3.5% down payment, you may still qualify with a 10% down payment.
- It can be easier to qualify. Lower credit scores and down payments are accepted and this loan type is more forgiving when it comes to bankruptcies and other financial issues.
- You must pay a mortgage insurance premium, regardless of the size of your down payment.
- You can refinance an FHA loan to lower your rate or change your term or even to take cash out.
It can be easier to qualify for an FHA loan. Lower credit scores and down payments are accepted and this loan type is more forgiving when it comes to bankruptcies and other financial issues.
What is a Conventional loan?
Conventional loans are the most popular option for borrowers looking to purchase or refinance a home. Borrowers may choose between fixed- and adjustable-rate mortgages with terms from 10 to 30 years. Conventional mortgages are not insured or guaranteed by any government agency. They are granted by private mortgage lenders, such as banks, credit unions, and other financial institutions. Credit standards are a little more strict than with FHA loans. Depending on specific loan characteristics, you could put down as little as 3% for a credit score as low as 620.
A few other things to consider about Conventional loans:
- You can use a Conventional mortgage to purchase a primary residence as well a second home or investment property.
- Depending on specific loan characteristics, you could put down as little as 3%.
- You have the option of choosing between an adjustable or a fixed-rate mortgage.
- You can refinance a Conventional loan to lower your rate or change your term or even to take cash out.
Conventional mortgages are granted by private mortgage lenders, such as banks, credit unions, and other financial institutions.
What are the pros and cons of FHA loans and Conventional loans?
All mortgages have characteristics that may be advantageous and disadvantageous depending on your specific scenario. It’s best to speak with a mortgage loan originator about which option best suits you. Here are the most common pros and cons of FHA and Conventional loans.
Pros and cons of FHA loans
FHA loans are generally popular among first-time homebuyers who don’t have a large down payment saved up, or have experienced bumps in their credit history. Here are some important factors to consider.
FHA loans can be easier to qualify for. FHA loans have less restrictive requirements on debt-to-income ratio and are more forgiving of past bankruptcies or foreclosures.
Low down payment
To qualify for the low down payment of 3.5%, you must meet a minimum FICO score specified by your lender. This score can vary from lender to lender, but it is generally lower than the score requirements of other loans, including conventional. If you do not have the minimum score, you may still be eligible for an FHA loan, but your down payment may increase to 10%.
Mortgage insurance premiums
Mortgage insurance is required on all FHA loans, regardless of down payment size. An FHA loan requires that you pay two types of mortgage insurance premiums — an upfront MIP (equal to 1.75% of the total value of your loan) and an annual MIP (charged monthly). Mortgage insurance protects the lender if the borrower defaults. If you have put at least 10% down at closing, you’ll be able to cancel MIP after 11 years of payment. If you have less than 10% down, you’ll pay MIP for the entire term length.
You can only use an FHA loan to buy a home you plan to live in as a primary residence. To finance a vacation or investment property, you’ll need to opt for a Conventional mortgage or another type of loan.
Pros and cons of Conventional loans
While it may be tougher to qualify for a Conventional loan, it may be the best option for borrowers who have stronger credit scores or more money for a down payment. Check out these pros and cons to see if it’s right for you.
3% down payment possible
Depending on certain loan characteristics, you could pay as little as 3% down on a Conventional loan. That’s even slightly lower than with an FHA loan.
More property type options
You can use a Conventional mortgage to purchase a primary residence, a second home, or even an investment property. FHA loans are only for primary residences.
Less impact from private mortgage insurance
With Conventional loans, you are required to pay mortgage insurance if you’re putting down less than 20%. However, if you save up enough for a 20% down payment, mortgage insurance will be waived. Even if you need to pay private mortgage insurance for the beginning of the loan, that can eventually be dropped after you reach 22% of your home’s equity.
Tougher qualification standards
There are more stringent requirements when it comes to getting approved for a Conventional loan than that of an FHA loan. You will need at least a 620 credit score to qualify for a Conventional loan.
I’m ready to apply. How do I get my VA Certificate of Eligibility?
There are two options when it comes to completing your COE application:
- Apply online here.
- Download, fill out, and mail VA Form 26-1880.
Applying online is the fastest way to get your COE. Sign in to your VA/DoD eBenefits account to access the application.
If you choose to apply by mail, you can find the correct mailing address on the last page of VA Form 26-1880 (it varies based on your location).
The COE application requires all the same information online or by mail, so the right choice for you is just a matter of which method you feel most confident with (and how quickly you need to get your COE). After submitting your application, it can take up to six weeks to receive your COE.
Which loan fits your needs?
Take the financial situations of two people, Hugo and Laila.
Hugo is trying his best to become a homeowner. However, after maxing out his credit cards and suffering a bankruptcy, his credit score is lower than he’d like it to be. He has a home in mind, but he’s only been able to save up about 4% for a down payment. An FHA loan may be right for Hugo. Since we’ve learned that FHA loans offer more flexible credit qualifying guidelines than other loan types, a lender may be able to offer Hugo a competitive interest rate.
Hugo may have a strong enough credit score to qualify for financing on an FHA loan, depending on the minimum qualifications required by his lender (the minimum required FICO score can vary from lender to lender, but it is generally lower than the score requirements of other loans, including Conventional).
Depending on his credit score, Hugo may be able to qualify for the low down payment of just 3.5% on his home’s purchase price. If his credit score is too low for that qualification, Hugo may still be eligible for an FHA loan, but his down payment may increase to 10%.
Now consider Laila: She’s spent the past few years building up strong credit, and has been able to save up a 15% down payment for a home in her price range.
Like roughly two-thirds of most homeowners, she’ll likely be eligible for a Conventional loan. While she may need to pay a little private mortgage insurance, it won’t be long at all before she can wipe that requirement away and focus on building equity in her new home.
Now you’re up to speed on the differences between FHA and Conventional loans. If you’re interested in exploring which option is best for you, the next step is to speak with a licensed mortgage loan originator. Contact us today to get started!