FHA vs. Conventional Loans

5 Minute Read
Published on March 26, 2019
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Because conventional and FHA loans are two of the most popular loan options, you’ll likely come across these terms as you prepare to buy a home or refinance your mortgage. Let’s review how each one works so you can see which type is right for you.

FHA Loans

FHA loans are home loans backed by the Federal Housing Administration (FHA), a government agency created to help home buyers qualify for a mortgage. FHA provides mortgage insurance on loans made by FHA-approved lenders, protecting them from the risk of borrower default.

Because lenders are protected, they can afford to be more lenient when offering mortgages. For example, this means it’s possible to get an FHA loan with a lower credit score than other types of loans.

To offset this, FHA loans will typically include mortgage insurance as part of the borrower’s responsibility.

The Benefits of an FHA Loan

  • At Quicken Loans, FHA loans are available with a credit score of 580 and a down payment as low as 3.5%.
  • You may qualify for an FHA loan after a foreclosure or bankruptcy if you’ve maintained good credit.
  • You can use gift money to cover up to 100% of the down payment.

The Cons of an FHA Loan

  • You’ll have to pay an upfront mortgage insurance premium (MIP) as well as annual MIP, which is included in your monthly mortgage payment.
  • FHA loans are not available for second homes or investment properties.
  • In most counties, the FHA loan limits are less than conventional loans.

FHA Loans and Mortgage Insurance

Mortgage insurance is an insurance policy that protects the lender if the borrower is unable to continue making payments.

FHA loans require two types of mortgage insurance payments:

  • An upfront mortgage insurance premium of 1.75% of the loan amount, either paid when you close on the loan or rolled into the loan amount.
  • A monthly mortgage insurance premium (MIP) as part of your regular mortgage payments.

If your down payment was less than 10%, you’ll continue to pay monthly mortgage insurance for the life of the loan.

If your down payment was 10% or more, you’ll only have to pay mortgage insurance for the first 11 years of the loan before you can remove it.

Is an FHA Loan Right for You?

Thanks to more lenient credit requirements and a low down payment, FHA loans are a common loan option for first-time home buyers. They are also suitable for anyone who needs lower credit requirements to get a mortgage.

The FHA Streamline Refinance Program

FHA loans have another advantage – the FHA Streamline program allows you to refinance an FHA loan without some of the costs or steps needed for other types of refinances.  

This refinance option allows you to lower your monthly payments or interest rate faster because it doesn’t require a complete credit check or income verification. Often, an appraisal is not required.

The FHA Streamline refinance doesn’t allow you to roll closing costs into the new mortgage amount.

Conventional Loans

Conventional loans are the most common types of loans in the mortgage industry. They’re funded by private financial lenders and then sold to government-sponsored corporations Fannie Mae and Freddie Mac.

These loans have stricter requirements than FHA loans. You’ll need a higher credit score and a lower debt-to-income ratio to qualify for a conventional loan than you would with an FHA loan.

The Benefits of a Conventional Loan 

  • You can make a down payment as low as 3%.
  • If your down payment is at least 20%, you can avoid paying private mortgage insurance (PMI).
  • In most counties, you can typically borrow more than you can with an FHA loan.
  • Mortgage rates are typically lower for conventional loans than FHA loans.

The Cons of a Conventional Loan

  • You’ll have to pay PMI if your down payment is less than 20% of the loan amount.
  • The loan qualifications are stricter, requiring a minimum credit score of 620 and lower DTI ratio.

Conventional Loans and Mortgage Insurance

PMI is a type of mortgage insurance unique to conventional loans. Like mortgage insurance premiums do for FHA loans, PMI protects the lender if the borrower defaults on the loan.

You’ll have to pay PMI as part of your mortgage payment if your down payment was less than 20% of the home’s value. However, you can request to remove PMI when you have 20% equity in the home. Once you’ve reached 22% home equity, PMI is often removed from your mortgage payment automatically.

Unlike mortgage insurance for FHA loans, PMI offers different payment options. Borrower-paid PMI, or BPMI, does not require an upfront cost, and depending on the lender, you can request to have it canceled once you’ve reached 20% equity in your home. In most cases, it’s automatically removed once you’ve reached 22% equity.

Lender-paid PMI, or LPMI, is paid for you by your lender. The lender will raise your mortgage interest rate in order to incorporate the insurance payment they make on your behalf. This option may result in lower payments but is typically not cheaper over the life of the loan. LPMI cannot be canceled because it’s built into your interest rate.

Is a Conventional Loan Right for You

A conventional loan is a great option if you have a solid credit score and little debt. You can avoid PMI by paying 20% of the loan upfront, which will lower your mortgage payments.

If you’re unable to make a large payment upfront, conventional loans are available with a down payment as low as 3%. In most cases, borrowers save money in the long run with a conventional loan because there’s no upfront mortgage insurance fee and the monthly insurance payments are cheaper.

The Bottom Line

If you meet the requirements for both an FHA and conventional loan, take time to compare total costs. You can use a mortgage loan calculator to help see which loan will better serve your financial needs.

If you still have questions, we’re here to help! Speak with a Home Loan Expertby a calling us at (800) 769-6133.