FHA vs. Conventional Mortgages: What's the Difference?

5.11.2023 | Category: Article

When it comes to applying for a mortgage loan to purchase a home, there are two main options available: FHA (Federal Housing Administration) loans and conventional loans. While both types of loans help borrowers achieve their dream of homeownership, they have some key differences that borrowers should understand before choosing which option is right for them.

Down Payment Requirements

One of the biggest differences between FHA and conventional mortgages is the down payment requirements. FHA loans require a minimum down payment of 3.5% of the purchase price, while conventional loans typically require a down payment of at least 5%. However, borrowers with good credit can sometimes qualify for a conventional loan with a down payment as low as 3%.

Mortgage Insurance

Another significant difference between the two loan types is the mortgage insurance. FHA loans require both an upfront mortgage insurance premium (MIP) and an annual MIP, while conventional loans typically require private mortgage insurance (PMI) if the borrower puts less than 20% down. PMI can be cancelled once the borrower has paid down the loan to 78% of the original purchase price, whereas MIP on FHA loans is required until the loan comes to term, either when the loan is paid off, the property is sold or the loan is refinanced.

Credit Score Requirements

Credit score requirements are also different for FHA and conventional loans. FHA loans are usually more lenient with credit score requirements, often accepting borrowers with scores as low as 580. In contrast, conventional loans typically require a credit score of at least 620, although borrowers with scores in the 700s may qualify for better interest rates and loan terms.

Loan Limits

Another difference between FHA and conventional loans is the loan limits. FHA loans have specific loan limits based on the county in which the property is located, which are set by the Department of Housing and Urban Development (HUD).

In 2021, the maximum FHA loan limit for a single-family home in most areas is $356,362. In contrast, conventional loans do not have set loan limits but are subject to conforming loan limits set by the Federal Housing Finance Agency (FHFA). In 2021, the conforming loan limit for a single-family home in most areas is $548,250.

Qualifying Ratios

Both FHA and conventional loans require borrowers to meet certain debt-to-income (DTI) ratios to qualify for the loan. However, the ratios differ between the two loan types. FHA loans have a maximum front-end DTI ratio of 31%, which is the percentage of the borrower's gross monthly income that goes towards the mortgage payment, and a maximum back-end DTI ratio of 43%, which includes all monthly debt obligations. Conventional loans typically require a front-end DTI ratio of no more than 28% and a back-end DTI ratio of no more than 36%.

What other loan options might be available?

Aside from FHA and conventional loans, there are other types of mortgages that you may want to consider depending on your financial situation and goals. Here are some other mortgage options:

VA Loans
These are loans for eligible military veterans, service members, and their families. VA loans offer competitive interest rates, low or no down payment requirements, and no private mortgage insurance (PMI).

USDA Loans
These are loans for low-to-moderate income homebuyers in rural areas. USDA loans offer low or no down payment requirements, competitive interest rates, and flexible credit guidelines.

Both FHA and conventional mortgages have their own unique advantages and disadvantages, depending on the borrowers financial situation and preference. FHA loans may be a better option for borrowers with lower credit scores or those who can only afford a smaller down payment, while conventional loans may be a better option for borrowers with higher credit scores and a larger down payment.

Ultimately, it is important for borrowers to evaluate their financial situation and goals to determine what type of loan is right for them. When you’re ready to apply for a mortgage loan, contact a Mutual of Omaha Mortgage loan specialist to learn how you might qualify for the home loan of your choice.