Analyzing the Difference Between FHA Loans and Conventional Loans

As a prospective homeowner, your number one concern should be focused on securing the best mortgage possible. The same thing would be true should you be looking to refinance your current mortgage. As you begin your search for the right mortgage program, you should start the process by recognizing there are a lot of different mortgage options at your disposal, each one providing a different set of benefits. It’s your responsibility to find the mortgage program that is going to best suit your needs and circumstances.

In the following sections, we could lay out a discussion about 4 or 5 different mortgage options that you might have at your disposal. Instead, we would like to focus on 2 popular mortgage options: the FHA loan and the conventional loan.

What is an FHA Loan?

An FHA loan is a mortgage that has the full backing and guarantee of the Federal Housing Administration (FHA). Since such loans have government backing, it’s the U.S. government through the FHA that decides which loan approval requirements banks and private mortgage companies must apply to prospective borrowers.

It’s noteworthy that some FHA requirements are quite lenient as opposed to conventional loan requirements. At the same time, there tend to be more requirements, which make the FHA loan process more cumbersome.

FHA loan requirements put less emphasis on the creditworthiness of borrowers and the amount of down payment that is required. With some FHA loan programs, a borrower can qualify for a loan with a FICO score of 580+ and a down payment as low as 3.5% of the purchase price. The prospective borrower’s home equity would be used in lieu of a down payment as part of a refi.

The primary reason FHA standards are somewhat lower than those associated with conventional loans is that the FHA requires that borrowers purchase Up Front Mortgage insurance premiums or MIPs regardless of the loan amount. In aggregate, MIP insurance helps offset the FHA’s risk against defaults. MIP insurance requirements can range from the first 11 years of the mortgage to the lifetime of the mortgage, depending on the applicable FHA program. The standard MIP rate is 1.75% of the mortgage amount.

What is a Conventional Loan?

In the home loan/mortgage industry, the conventional loan is considered the standard-bearer. It is characterized by the simplicity of the mortgage approval process and the lack of government intervention.

Without government backing, the processing of conventional loans is a lot more straightforward. This results in banks and private mortgage companies requiring a lot less information from applicants before a lending decision is made. In fact, it’s up to each individual bank and private mortgage company to develop their own mortgage lending requirements.

For the most part, conventional loan lenders only require that borrowers have steady employment, a reasonable credit history, and a down payment of approximately 10% of the purchase price. For a loan refi, the prospective borrower’s home equity again would be used in lieu of a down payment. It’s worth noting that borrowers are required to purchase Private Mortgage Insurance if their down payment or home equity is less than 20% of the loan or equity value of the home.

There a two primary types of conventional loans: conforming and non-conforming. With a conforming loan, the lender/borrower is subject to following guidelines that are set forth by the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac). If borrowers have extenuating circumstances that warrant extra considerations, lenders/borrowers can choose to go with a non-conforming mortgage program that often comes with lower requirement thresholds.

Identify the Differences Between FHA Loans and Conventional Loans

After reading the aforementioned information related to FHA and conventional loans, you can see that some differences are very apparent. At the same time, there are some differences that are more subtle or not at all apparent. With all of this in mind, we want to lay out in bullet point fashion the difference between FHA loans and conventional loans.

Here is a list of the primary differences:

1. Duration of the loan approval process: Since the FHA loan process comes with more requirements, it takes a bit longer than that associated with conventional loans. As a rule of thumb, the FHA loan approval process takes 2 to 4 weeks in comparison to 1 to 2 weeks for conventional loans.
2. Credit score requirement: FHA FICO score requirements can go as low as 580 while conventional loan FICO score requirements are usually set at 620 or higher. In both cases, current credit and employment history will dictate what would be considered acceptable FICO score levels.
3. Debt-to-Equity Ratio: FHA loan programs allow for higher debt-to-equity quotients than conventional loan programs.
4. Home appraisal: FHA appraisers have to be FHA approved while conventional loans only require an appraisal from a state-licensed appraiser.
5. Down payment requirement: With FHA loans, there are loan programs that require down payments as low as 3.5%. By comparison, most conventional loan programs require a minimum down payment of 10%. In both cases, the percentage can vary based on borrower circumstances.
6. Mortgage insurance requirement: FHA loans come with a mandatory MIP mortgage insurance requirement of 1.75% of the loan amount on all mortgages. Conventional loans require the purchase and maintenance of PMI wherever the loan-to-value quotient is more than 80%
7. Interest rates: Interest rates tend to be slightly lower on FHA loans because of government backing. Also, conventional loan lenders tend to allow more risk in exchange for higher interest rates.

There you have it. With the above comparison between FHA loans and conventional loans, it should be easier for you to decide which type of loan will best suit your needs and personal circumstances. As you look for the best option, you would be well-advised to seek advice and shop for the right program before giving your thumbs up.