Oh, a brave new world where people would not have to think about where to get the money to buy a house! But for now, let's try to resolve this issue and make a choice — take a Federal Housing Administration (FHA) or use a conventional loan. In this article, we will tell you how the two lending systems work, and what are their pros and cons. But the final choice, of course, will be yours. So, let’s see what's the difference between conventional loan and FHA? 

How does a conventional loan work?

Conventional loans can be obtained from traditional lenders such as a mortgage company or a bank. Also, third parties: credit unions, creditors, and charitable organizations provide them. Loans made by federally regulated borrowers Fannie Mae and Freddie Mac are also considered ordinary loans. 

There are two types of conventional loans:

  • Confirmation loans — the name speaks for itself. Such loans meet a set of standards set by the Federal Housing Finance Agency (FHFA): credit, debt, and loan size. In 2023, credit limits reach $726,000 in most areas and $1,000,000 in high-cost areas.
  • Non-confirmation loans — do not meet the standards of the FHFA. Such loans are suitable for borrowers who are determined to buy more expensive homes or for buyers with an unusual credit history.

Advantages of conventional loans:

  • the total cost of the loan is, above all, lower than for other mortgage loans;
  • the initial payment can be only 3%;
  • it is possible to cancel private mortgage insurance (PMI) when reaching 20% of equity. Or refinance to remove it.

Disadvantages of conventional loans: 

  • a minimum FICO score of 620 or higher is required;
  • if the down payment is less than 20%, you will have to pay PMI;
  • a large amount of documentation to confirm income, assets, down payment, and employment.

Who are conventional loans suitable for? 

A conventional loan is a good choice for people with a good credit score who can afford to make a down payment. It’s not surprising that a 30-year conventional fixed-rate mortgage is the most popular choice among homebuyers..

What is an FHA loan? 

The Federal Housing Administration (FHA) is one of the authorities, which supports mortgages for Americans. Thus, with the support of the FHA, loans are provided at competitive interest rates. This helps borrowers purchase housing without a large down payment.

What are the conditions for obtaining a loan?

  • minimum FICO score of 580 to receive the maximum FHA funding of 96%. Also, a valuation of up to 500 is allowed if you deposit 10% of the original amount;
  • the loan requires two mortgage insurance premiums — this can increase the total value of your mortgage.

Advantages of FHA loans:

  • this will help finance the purchase of a house in case a person is not eligible for a regular loan;
  • softer credit requirements;
  • no big down payment.

Disadvantages of FHA loans:

  • obligatory mortgage insurance premiums — they can only be canceled when refinancing into a conventional mortgage;
  • possible high costs of borrowing;
  • providing additional documentation to confirm the right to a loan.

Who are FHA loans suitable for? 

If this is your first time buying a home, but you have a low credit rating and a fairly low income, then an FHA loan might be a great option. The FHA will even provide insurance if you have a credit score of only 500. But, we emphasize that then you will have to pay a down payment of 10% instead of 3.5%.  It's not too bad if you have that amount, but your credit score is not very high. However, while you are actively using FHA credit to pay for your home, you must also pay mandatory mortgage insurance.

So what's the difference between conventional loan and FHA?  

FHA loans have less restrictive credit requirements than conventional. Loans from the Federal Housing Administration allow for approval with a low credit score and a 10% down payment. A minimum down payment of 3.5 percent is required for a credit score above 580. Conventional loans require a lower down payment (3%) but a higher credit score of at least 620 to qualify. When choosing between a regular loan and an FHA loan, you need to consider the cost of mortgage insurance. If you have invested less than 10% on an FHA loan, you must pay mortgage insurance for the life of the loan, no matter how much equity you have. On the other hand, once you reach 20% equity on a regular loan, you won't have to pay for private mortgage insurance.

Which one should I choose? 

Conventional loans are more flexible but riskier because they are not federally insured. This makes it difficult to get a standard loan that protects you financially.  If you have a strong credit history, a conventional loan is preferable because your mortgage rate and PMI fees will be lower. However, if your credit score is above 500 or below 600, an FHA loan may be ideal. FHA is an alternative for clients with bad credit history. Also, conventional loans can be a smart cost-cutting solution and are one of the most common options for borrowers. Getting your credit score, income, and assets in order is the best approach to getting a regular loan. Keep in mind that while some lenders are willing to be flexible when applying for a regular loan, you usually need to make up for a deficiency in one area.  For example, if your credit score is low, you will usually need a larger down payment and a higher salary. In general, if you have a down payment, sufficient income, and an appropriate credit score, you should be able to get a conventional loan. 

Conclusion

Of course, choosing the type of lending is a personal matter for everyone. This will be the answer for you to the question — what's the difference between conventional loan and FHA? As far as we have seen in this text, it depends on many factors: income level, credit rating, and housing cost. In any case, the possibilities are many, so you just have to make the right choice before buying the property of your dreams. At LBC Mortgage, we take care of all the concerns of our clients, work with documents, and select the best financing options. Sign up for a consultation and save time and money.