What Is the Difference Between a FHA Loan and a Conventional Loan?

Owning a home is part of everyone’s American Dream. Mortgages make it easier for home-buyers to do just that. Essentially, there are three types of mortgages: conventional home loans, Federal Housing Administration (FHA) loans and VA loans for veterans and military service people.

Conventional loans and FHA loans serve the same purpose of helping Americans own homes. However, there are several important differences between the two. Knowing these differences will help home-buyers realize the best homeowner financing. Keep reading to better understand the differences between these home loans.

Conventional Loans Versus FHA Loans

  1. Government Backing

The main difference between conventional loans and FHA loans is that conventional loans are originated from the private sector and are not backed by the federal government while FHA loans also originate from the private sector but are backed by the federal government.

The government does not issue FHA loans, it simply insures them.

This means that lenders who issue conventional loans do not have a government-backed guarantee that the loan will be paid if the borrower defaults while lenders issuing FHA loans have a government-backed guarantee that the loan outstanding will be paid if the borrower defaults.

Because they are not insured by the government, conventional loans are usually issued to people with good credit standings or on solid financial footing. FHA loans, on the other hand, are usually issued to people with less-than-stellar credit scores and first-time home buyers.

In practice, however, conventional loans can be insured by third party insurance companies.

  1. Loan Approval

The process of approval for the two loans is also different. With conventional loans, the borrower only has to meet the lender’s minimum acceptable requirements for approval. These include good credit score, low debt-to-income ratio (many lenders require a borrower’s total monthly debt payments including student loans and car loans to be less than 45% their monthly income), a significant down payment (5%-20% of total amount) and adequate documentation to prove income, legal residence, home address and assets owned.

For FHA loans, the borrower has to meet two sets of requirements: the lender’s and the government’s. While this means these loans will take longer to process, the requirements are usually less stringent. For example, a borrower can get a loan with a low credit score, a debt-income ratio of up to 56% or a down payment of as low as 3.5%. Additional requirements are set by the Department of Housing and Urban Development, the federal agency managing the FHA loans program.

Interestingly, despite the two-tiered qualification system, it is easier to get approved for an FHA loan than a conventional loan because the former is guaranteed by the government.

  1. Closing Costs

Fees such as lender fees, third party insurance fees and down payments mean a conventional loan borrower has to come up with a significant sum of money at closing. For FHA loans, the down payment and third party fees can be lower at closing. However, borrowers will have to pay an upfront mortgage insurance premium of 1.75%-2.5% of the loan amount at closing.

  1. Flexibility

Conventional loans have way more flexibility than FHA loans, especially for borrowers with really good credit standing. Lenders are usually ready to offer competitive rates and lower closing fees.  Some lenders even have programs that allow flexibility in their qualification requirements like approving borrowers with high debt-to-income ratios if they own significant assets.

Choosing between a conventional loan and an FHA loan is not easy. The loan experts at Community Mortgage can answer your questions and help you reach an informed decision that is right for you.

Posted in: FHA Loans