Whether you’re looking to buy a new home or refinance your mortgage, there are many loan options available on the market. Two of the most popular options are conventional loans and FHA loans.
Both types of loans have their advantages and disadvantages, depending on your circumstances. With that in mind, let’s go over these two types of loans and figure out which one might be best for your situation.
As the name would suggest, these loans are basically the bread and butter of the mortgage world. Conventional loans, sometimes referred to as agency loans, are mortgages offered through Fannie Mae or Freddie Mac, government-sponsored enterprises (GSEs) that provide funds for mortgages to lenders.
Conventional loans have a higher bar for approval than other types of loans do. They tend to be good for borrowers with good credit and a low debt-to-income (DTI) ratio who can make a down payment of 20%, as this allows them to avoid paying for private mortgage insurance (PMI).
However, conventional loans also allow down payments as low as 3%. With any down payment less than 20%, you’ll have to pay for PMI until you reach 20% equity in your home. There are also options for lender-paid mortgage insurance (LPMI), where you either make a one-time lump-sum payment at the start of your loan or take on a higher interest rate in exchange for the lender paying for your mortgage insurance.
To qualify for a conventional loan, you’ll need a credit score of at least 620 and a DTI no higher than 50% (ideally, it should be lower so you get better loan terms).
- Allows low down payments
- No PMI with down payments of 20% or more
- PMI can be removed once you reach 20% equity
- Ability to get LPMI (like PMI Advantage)
- Flexibility in terms – can select any repayment period between 8 and 30 years
- Can be used to buy primary residences, vacation homes and investment properties
- Harder to qualify for than other loan types
- Paying for PMI with down payments lower than 20%
FHA loans are government-backed home loans insured by the Federal Housing Administration. They have slightly less stringent qualification standards, making them a good choice for first-time home buyers or borrowers with less-than-ideal credit.
The minimum down payment for an FHA loan is 3.5%. With FHA loans, you’ll pay for mortgage insurance (referred to as mortgage insurance premium, or MIP, for FHA loans) for the life of the loan if you make a down payment less than 10%. With down payments of 10% or more, you’ll make MIP payments for 11 years. However, once you have 20% equity in the home, you can refinance into a conventional loan, where you won’t pay mortgage insurance.
With an FHA loan, borrowers with credit scores of 580 or higher can qualify for a loan. Additionally, if you have a higher DTI (no higher than 50%), you may still qualify if you prove to be creditworthy in other areas, such as having a good credit score or being able to make a large down payment.
- Easier to qualify for
- Allows lower down payments
- Accepts lower credit scores
- Accepts higher DTI in certain cases
- With a minimum down payment, requires MIP for the life of the loan, or 11 years for a down payment of 10% or more
- Upfront mortgage insurance premium (1.75% of the loan amount)
- Less term flexibility (15-, 20-, 25- and 30-year options)
- Not available for second homes or investment properties
Which One Should You Choose?
To figure out which one is best, you need to consider your situation. If you’re a first-time home buyer with just alright credit and a high DTI, you may find that an FHA is your best, or only, option. If you don’t have the cash to make a large down payment but are able to qualify for a conventional loan with a smaller down payment, compare the interest rates and the insurance costs you’d take on with each type of loan. Once you know what the overall costs would be over the lifetime of the loan, you’ll be able to decide which one will likely work best for your needs and budget.
There’s no one-size-fits-all loan. If you’re still having trouble figuring out what’s right for you, speak with a financial advisor. They’ll be able to look at your options and make a recommendation that’s based on your personal financial circumstances and goals.
If you’re ready to get started, you can do so online through Rocket Mortgage® by Quicken Loans. If you’d rather get started over the phone, give us a call at (800) 785-4788. Still on the fence? We can help answer your questions in the comments below.
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