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FHA Loan vs. Conventional Mortgage

April 4, 2022

Buying a home may be one of the biggest purchases you’ll make. At first, it might seem overwhelming to decide which mortgage loan works best for your current (and future) budget. Understanding the difference between an FHA loan vs. conventional loan is a good starting point. 

Once you understand what they are and how they’re different, you can match the right loan to your financial situation and maybe even save money along the way! Read on to learn more about two of the most popular loan options available.

FHA Loan vs. Conventional Loan: What Are They?

The Federal Housing Administration (FHA) is the largest mortgage insurer in the world and has insured over 46 million mortgages since 1934. FHA loans are indeed ideal for someone purchasing a first home. However, FHA loans are available to any buyer seeking a government-backed mortgage whether or not you’re a first timer.

You can use a conventional loan to buy a primary home, vacation home, or investment property. These loan types are often bought by two government-created enterprises: Freddie Mac and Fannie Mae. Conventional loan guidelines go by standards set by Freddie Mac and Fannie Mae. We’ll cover qualification requirements for both loan types next.

Qualification Requirements

There are many factors to consider when debating between an FHA or conventional mortgage. Your credit score, debt-to-income ratio, and the amount of your down payment are all factored into which loan type you choose. 

Credit Score

The length of your credit history, what type of credit you have, how you use your credit, and how many new accounts you have will be taken into consideration first. Conventional loans typically require a higher credit score since this is a non-government-backed loan. Aim for a minimum score of 620 or higher. 

Debt-to-Income (DTI) Ratio

Your DTI ratio represents how much of your monthly income goes toward the debt you already have. Expenses such as a car payment or student loan are all considered in the loan application process. You can calculate your DTI with this formula: 

(Total monthly debt) / (Gross monthly income) x 100 = DTI.  

You may be able to have a higher DTI for an FHA loan but these loan types usually allow for a 50% debt-to-income ratio. A conventional loan tends to prefer a maximum DTI of 45% or less. The lower your DTI, the better. If your ratio is close to the maximum, having a higher credit score or a good amount of money saved up could help!

Down Payment

Your credit score will also impact the amount of your down payment. FHA loans allow for down payments as low as 3.5%, whereas a conventional loan allows you to make a 3% down payment. Keep in mind, a larger down payment can eliminate the need for private mortgage insurance on a conventional loan.

On either mortgage, the more you pay upfront, the less you need to pay in interest over the life of your loan. Putting 3.5% versus 10% down can have a huge impact on your monthly payment as well.

Interest Rates

Your rate is your borrowing cost, expressed as a percentage of the loan amount. Mortgages are often discussed in terms of their APR (annual percentage rate), which factors in fees and other charges to show how much the loan will cost each year. 

A fixed-rate mortgage has the same interest rate for the whole term, giving you more consistent monthly payments and the ability to avoid paying more interest if rates go up. This is the best choice if you plan on staying in your new home long-term. 

At Fibre Federal Credit union, we offer fixed-rate mortgages in 15-, 20- and 30-year terms for conventional loans. For FHA Loans, apply for our 30-year fixed option.

FHA Mortgage Insurance

Mortgage insurance is an insurance policy that protects your lender in case you can’t make your payments. FHA loans require mortgage insurance in every situation regardless of your credit score or how much of a down payment you make. There are two types of mortgage insurance premiums (MIP): upfront and annual. 

Every FHA mortgage includes an upfront premium of 1.75% of the total loan amount. The annual MIP is dependent on your down payment. With a 10% or higher down payment, you only pay mortgage insurance for 11 years. Less than a 10% down payment will usually mean paying the MIP for the entire life of your loan.

Which One Should I Choose?

An FHA loan makes the most sense if you’re purchasing a primary residence. It’s the better option if you have a good amount of debt and know your credit score is below 620. FHA loans may have fewer upfront costs because in most cases, the seller can pay more of the closing costs. 

Conventional loans are most attractive if you have a higher credit score and less debt. They don’t require mortgage insurance premiums with a large down payment, which can be significant savings on the monthly payment.

If you’re looking for something other than a primary residence, such as a vacation home or rental property, then you can only consider a conventional loan. Conventional loans are also more appropriate for more expensive homes as they have higher maximum limits. Compare both options with your personal financial history to see which is best for you!

FHA Loan vs. Conventional Loan: Find Your Dream Home with Fibre Federal Credit Union!

There are many differences between an FHA loan vs. conventional loan for your mortgage. But taking a little bit of time to understand the difference can save you time and money in the long run. 

Read more below to decide which mortgage is best for you!

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