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Home Financing: FHA Loans Versus Conventional Loans

FHA loans and conventional home loans are two common types of home mortgages, but what they actually mean is often unclear to not only buyers but also sellers. The differences between FHA loans and conventional loans come down to a number of factors ranging from a buyer’s credit score and down payment to loan caps and property standards.

What Is an FHA Loan?

FHA stands for the U.S. Federal Housing Administration, which was created in 1934 as a way to make homeownership more accessible for more Americans. Standards for buyers are less stringent than those for a conventional loan, for example, and mortgage issuers must be FHA-approved lenders. Meanwhile, the government guarantees all FHA loans against borrower defaults. In return, all FHA loans must comply with the associated guidelines:

  • You can get an FHA loan with a credit score as low as 500.

  • The home you are mortgaging with an FHA loan must be your primary residence.

  • The amount you need for a down payment is tied to your credit score. If you have a score of 580 or above, you’ll need to put down 3.5 percent of the purchase price. If your score falls in the 500-to-579 range, you’ll need to put down 10 percent of the purchase price.

  • Mortgage insurance is mandatory and consists of both an upfront premium at closing as well as monthly or annual mortgage insurance payments. Premiums typically extend for the life of the loan if your down payment was less than 10 percent or for 11 years if your down payment was 10 percent or more.

  • Your debt-to-income ratio—the amount of money you owe versus the amount of money you make, for example—can be as high as 50 percent. However, many lenders consider 43 percent a safer, preferred figure for approval.

  • Regulators set loan limits annually. For 2021, FHA loan caps are $356,362 in most areas and $822,375 in more expensive areas.

  • FHA loans are eligible for refinancing through FHA’s streamline refinancing programs or through a conventional loan.

  • FHA loan approval is subject to a home appraisal that also assesses the property’s condition and safety.

Benefits of an FHA Loan: FHA loans are set up to help individuals who may not have much of credit history or the money for a 20-percent down payment purchase of a home. The financial requirements are less stringent than those for conventional loans, making qualification for an FHA loan easier.

Drawbacks of an FHA Loan: Mandatory mortgage insurance is an added expense that typically extends well beyond the 20-percent equity mark of most conventional loans.

Considerations for an FHA Loan: The FHA home appraisal ensures not only that the property has a financial market value in line with the purchase price but also that the property is structurally sound, hazard-free and livable for the term of the mortgage. These appraisals are in place to protect buyers as well as lenders, so appraisals may cite problems or irregularities that sellers must repair or remediate prior to closing.

To learn more about FHA Home Loan qualifications and to see if you’re eligible, contact our expert mortgage originators today

The Conventional Home Loan

Conventional home loans are not government-guaranteed. Instead, private or commercial lenders underwrite them for individuals who meet their particular loan application criteria. Requirements typically follow guidelines set by Fannie Mae or Freddie Mac, for example, for conditions like down payments and debt-to-income ratios while loan limits usually follow Federal Housing Finance Administration recommendations. 

However, requirements for conventional loans tend to be a bit more demanding in some areas while being laxer in others:

  • Your credit score needs to be at least 620, but if you have a 740 or better, you’ll be able to get the best interest rates and terms available.

  • You can use a conventional loan to purchase various types of property—your primary residence, a second home or vacation property, for example.

  • For a down payment, you may be able to put down as little as 3 percent, but lenders may offer better interest rates based on larger down payments like the traditional 20 percent.

  • A down payment of 20 percent of your purchase price or appraised value will let you avoid private mortgage insurance—PMI—premiums. If you do have to pay PMI initially, you can drop it once you cross the 20-percent equity threshold.

  • Loan limits follow Fannie Mae and Freddie Mac guidelines for conforming versus non-conforming loans. For 2021, conforming loans are capped at $548,250 for most areas and $822,375 for more expensive areas. Nonconforming or jumbo loans are designed for buyers purchasing a home priced beyond their area’s value limits.

  • Conventional loans offer more customizable features like terms—30, 20 or 15 years, for example—or types of loans, like fixed-rate versus adjustable rate.

  • You can refinance whenever you want, as long as you fulfill the requirements of your note.

  • The appraisal focuses on the property’s market value as compared to similar properties and sales.

Benefits of a Conventional Loan: For buyers who have a solid credit score and the financial resources to put down a 20-percent down payment, conventional loans offer highly competitive interest rates, no PMI and a variety of mortgage lending products to work for any situation or time frame.

Drawbacks of a Conventional Loan: Buyers need to put down more money upfront for the down payment. Meanwhile, debt-to-income ratios and credit scores are key in determining interest rates and eligibility.

Considerations for a Conventional Loan: The appraisal process for conventional loans addresses the property’s market value in regard to comparable properties only. To establish a property’s soundness or safety, buyers must initiate their own inspections and exercise due diligence to ensure repairs or remediations are complete prior to closing.

Our mortgage loan experts would love to walk you through the conventional loan process. Contact them today to learn more

Weighing Your Home Mortgage Options

When you’re thinking of buying a home and looking for a mortgage, the type of loan you choose needs to be a good fit for you and your financial situation. If you’re ready to learn more about your home loan options, La Capitol Federal Credit Union’s mortgage specialists can help. Reach out to La Capitol online or visit us today, and let us help you make the best decision for your next home purchase.


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