The primary difference between FHA and conventional loan programs is that FHA loans are insured by the government’s Federal Housing Administration, while conventional loans are not insured by the government. Conventional loans do have some government oversight, however, as they must follow Freddie Mac and Fannie Mae guidelines. FHA and conventional mortgages also differ in their requirements in terms of down payments and credit scores, with each type of mortgage loan suiting a different type of buyer.
Do FHA and Conventional Loans Require Similar Credit Scores and Down Payments?
The government created the FHA loan program to make home ownership more accessible to buyers who may not have been able to qualify for or afford conventional loans based on their down payments and credit scores. Buyers with a credit score of 580 or higher may qualify for an FHA loan with a down payment as low as 3.5 percent, and borrowers with credit scores between 500 and 579 may need to put down at least 10 percent. If you have insufficient credit or a credit history that is nontraditional, you may still qualify for an FHA loan.
Since conventional mortgages are at the whim of private lenders, borrowers may qualify for them with less-than-stellar credit scores and low down payments, but they’ll pay for it in the end with higher interest rates, more money due at closing and higher monthly payments. To qualify for a conventional mortgage with only 5 percent down, a private lender will probably require a credit score of at least 620. Even with a score of 620, you may have difficulty getting an affordable conventional mortgage, especially if you’re self-employed or your income is on the low end.
Are Debt-to-Income Ratios the Same for Both Types of Loans?
The debt-to-income ratio (DTI) is one piece of criteria lenders look at when deciding whether you’re a good risk as a borrower and how much you can qualify for. There are two DTI numbers lenders look at: the front-end ratio, which measures your housing expenses against your income, and the back-end ratio, which compares your total debt to your monthly gross income.
Your housing expense consists of your mortgage payment, insurance, taxes and HOA fees, but it does not take maintenance, repairs and utilities into consideration. Your total debt combines your housing expense with your fixed recurring debts, such as credit cards, student or auto loans or personal loans.
Conventional mortgage lenders typically want to see a front-end ratio that is 28 percent or less and a back-end ratio that is 36 percent or less. If you have a very solid credit score, a large down payment or other significant assets, they may waive those requirements. The FHA wants to see a front-end ratio of 31 percent or less and a back-end DTI of 43 percent or less.
Is There a Limit On the Amount I Can Borrow?
One difference between FHA and conventional loan programs is that the FHA has lending limits that vary based on the type of home and its geographic location while conventional mortgage lenders base the amount they will lend on the home’s value, your credit history, the amount of your down payment and your income. For example, the FHA limits the amount it will loan to a borrower in the San Francisco area to $615,500 for a single-family home, $800,775 for a duplex, $967,950 for a tri-plex and $1,202,925 for a four-plex. In Florida’s Gainesville area, the limits are $271,050 for a single-family home, $347,000 for a duplex, $419,425 for a tri-plex and $521,250 for a four-plex.
Will I Be Required to Carry Insurance on my Mortgage?
If you’re taking out a conventional mortgage and have a down payment of less than 20 percent, you may be required to carry private mortgage insurance (PMI) on your loan. Private lenders often make exceptions for buyers with a high credit score or other assets. Since FHA mortgages only require a 3.5 percent down payment, borrowers must pay mortgage insurance premiums (MIP) on their loans.
Are PMI and MIP Similar?
PMI and MIP are similar in that they both protect the lender in case the borrower defaults on the loan. They do not offer any protection to the borrowers if they default on the loan, and the lenders may opt to foreclose. Except for the basic principle of the insurance, MIP and PMI are very different.
When a conventional mortgage lender requires a borrower to pay for PMI, the borrower must only pay the premiums until his equity stake reaches 20 percent or the loan-to-value ratio reaches 80 percent. This may happen naturally as the borrower makes mortgage payments, the housing market where the home is located may take an upturn that raises the home’s value or the homeowner may make improvements on the home that increases its value. If a lender reaches the midpoint of the loan and still hasn’t reached a 20 percent equity stake, the lender must terminate the PMI per the Homeowner’s Protection Act.
If you take out an FHA loan and are required to pay MIP, there is no turning back. The FHA mandates that MIP be in place for the life of the loan. The only way to get rid of MIP payments with an FHA loan is to either pay off the mortgage or refinance the loan. The FHA may also require a lump-sum, up-front premium known as UPMIP.
