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How Are FHA Loans Different from Conventional Loans?

Category: Finance

Wondering if you should apply for an FHA loan or conventional loan? Then you need to understand how these two differ from one another in order to make the right decision.

The type of mortgage you ultimately pick would depend on the specific kind of house you’re looking to purchase, the particular trade-offs you’ll need to make when weighing the benefits of each mortgage type, and your financial circumstances.

Basic Approval Requirements

Since FHA loans come with low down payment requirements, they’re generally easier to qualify for than conventional loans, especially if your credit isn’t exactly stellar or if you’ve filed for bankruptcy in the past, says an experienced FHA loan broker in Gilbert.

Likewise, with FHA loans, you can choose to solicit help from a co-borrower. When opting to take out an FHA loan with a co-borrower, he or she needs to be a blood relative that’ll help with the mortgage payments but won’t live with you in the house you intend to buy.

The lender will combine both of your debt and income levels into one DTI or debt-to-income ratio when calculating your overall creditworthiness.

The LTV Ratio and Down Payment Requirements

Conventional loans usually come with lower loan-to-value or LTV ratios than FHA loans. The simple reason for this is that the FHA or Federal Housing Administration isn’t actually the one who services or issues the mortgage, FHA-approved private lenders do, and the FHA insures or guarantees the loan, which reduces the risk for lenders.

In addition, with a conventional mortgage, you’ll need at least a 20% down payment to obtain an affordable interest rate, while you’ll only need about 3.5% down payment with an FHA mortgage.

Clipboard with FHA 203k loan form in an office.Flexibility

It is kind of difficult to say which loan type can offer more flexibility. With an FHA mortgage, you can get a co-borrower to help you qualify and pay for mortgage payments, and your loan can be assumed another borrower when you want to get rid of your home and relocate.

On the other hand, you can use conventional mortgages for purchasing vacation homes or investment properties and are available in jumbo loans, which are options that FHA loans don’t offer.

Mortgage Insurance Requirements

Mortgage insurance is required for all FHA loans. This means that when taking out an FHA loan, you will need to pay an insurance premium upfront as well as a monthly premium.

With a conventional loan on the other hand, if your down payment is less than 20%, you’ll need to pay for private mortgage insurance (PMI). However, once your LTV ratio reaches below 78%, you can request that your lender cancel your monthly PMI charges. Additionally, if you can come up with a down payment of 20% or higher, you won’t even need to purchase PMI.

For most borrowers, the choice of whether to go with a conventional loan or FHA loan won’t really depend on what features each mortgage type offers. Instead, it will come down to whether or not they can balance their overall borrowing costs when they take into consideration the interest rates, savings, and insurance requirements they’ll face with the loan type they choose.