Mortgage Advice

Conventional vs. FHA Loans: Which is Right for Me?

May 1, 2015

When it comes to buying a house, you want to spend as much time evaluating your mortgage loan options as you do searching for the perfect home. After all, buying a home is a major investment and there is no such thing as a one-size-fits-all-solution.

There are many different types of mortgage loans, each with unique advantages. The key to obtaining a mortgage you can live with is working with a loan officer who can help you weigh the pro’s and con’s of each, as it relates to your situation and financial goals. 

However, there’s more to choosing a mortgage than evaluating fixed and adjustable-rate loans and a 15-year or 30-year term. You’ll also want to consider whether you want a conventional loan or an FHA loan. Let’s discuss the advantages and drawbacks of each.

What is an FHA loan?

An FHA loan is a type of government loan that is insured by the Federal Housing Administration and issued by FHA-approved lenders.

Who is FHA financing for?

Designed for low-to-moderate income borrowers who may have blemishes on their credit history, FHA loans typically have less stringent underwriting guidelines than conventional loans.

Advantages of FHA loans

  • FHA loans are a great low down payment option: The down payment requirement for an FHA mortgage starts as low as 3.5% and is ideal for first-time homebuyers who are just starting to build their credit and their savings.
  • Down payment and money for closing may be gifted by a relative: Another benefit of the FHA loan program is that borrowers can use gift money and government grants to help with their required down payment.
  • Easier to qualify for based on more generous credit qualifying criteria: The lending guidelines associated with FHA financing are traditionally less stringent than conventional financing, making it easier to qualify for an FHA loan. The Federal Housing Administration also allows for some negative credit marks without interest rate penalties.

Drawbacks to consider

  • Private Mortgage Insurance (PMI) is required and cannot be removed: FHA loans are subject to upfront and annual mortgage insurance premiums. Although FHA loans tend to come with slightly lower interest rates, additional costs, such as PMI and upfront premiums, should be taken into account when evaluating the benefits of conventional vs. FHA loans. The additional costs may actually result in a higher monthly mortgage payment and cause you to pay more over the life of the loan.
  • Processing may take longer than conventional loans: Some loan programs, such as FHA loans, actually have a longer processing time than conventional loans.
  • Property guidelines may be stricter than conventional loans: Because FHA mortgages are insured by the government, there are typically stricter appraisal guidelines. The property in question must meet certain criteria before it can be approved for FHA financing.

What is a conventional loan?

Unlike FHA loans, conventional mortgage loans are NOT insured through government programs. Instead, conventional loans have a separate set of funding criteria and are backed by Fannie Mae and Freddie Mac.

Who is conventional financing for?

Traditionally, conventional loans suit the needs of homebuyers who have strong credit and can afford a higher down payment.

Advantages of conventional financing

  • No mortgage insurance premium required: Unlike FHA loans, conventional loans do not include upfront mortgage insurance premiums. Conventional borrowers also have the ability to get rid of PMI once they reach 20% equity in their home, where as FHA loans do not offer the option to remove PMI.
  • New low down payment options: While FHA loans are attractive for their low down payment options, Fannie Mae and Freddie Mac announced a new conventional loan program that allows homebuyers to purchase a house for as little as 3% down. Geared toward homebuyers who want the benefits of a conventional mortgage but lack the resources to save for a large down payment, this new 3% down payment program reduces the upfront cost of purchasing a home.
  • Flexible terms: With conventional financing, homebuyers have the convenience and flexibility of choosing between several repayment options, including the ability to have a fixed or adjustable rate mortgage, as well as a 15, 20 or 30-year term.
  • Conventional loans can be used to finance practically any property: Some types of properties (condos, etc.) aren’t approved for FHA financing. Conventional loans are accepted for just about any property.

Drawbacks to consider

  • Stricter lending guidelines: Historically, conventional loans tend to have tougher standards when it comes to lending guidelines and requirements. This typically includes higher credit score criteria and income requirements.
  • Mortgage rates for conventional loans are typically higher than FHA rates: While the rates for conventional mortgage loans have been historically higher than FHA rates, we’re currently experiencing record interest low rates across the board, which should excite anyone who’s thinking about buying a home. Plus as mentioned above, the additional mortgage insurance premiums associated with FHA financing may actually cancel out any cost-savings achieved through a lower rate.
  • Mortgage insurance is required for loans with a down payment of less than 20%: While this may be the case, conventional borrowers can remove PMI payments once they obtain 20% equity in their home, whereas FHA borrowers do not have this luxury.

The key thing to remember when shopping for mortgage loans is to evaluate all of your options. There’s more to it than getting a great low rate! Be sure to work with a mortgage lender that has your best interest at heart and will work with you to find a mortgage loan that fits your financial needs.

If you are serious about buying a house and want to figure out which loan is best for you, send us a message! We’d be happy to help you determine which loan you would qualify for and compare the cost of each loan.