Conventional Mortgage Or FHA Loan: Which Is Right For You?
Before you begin looking at mortgage options it's important to know the key differences between two of the most popular options: FHA and Conventional loans. Each come with their own pros and cons. In today's competitive State College housing market, you'll want to be sure you're equipped with as much information as possible.
What is an FHA Loan?
An FHA loan is a type of loan given out by the Federal Housing Association. These loans are insured by the government. Only banks and lenders that are approved by the agency are allowed to offer these loans. FHA loans are designed to give lower income families and individuals a better opportunity at being accepted for a mortgage. However, anyone can apply for one.
D. Shane Whitteker is the owner and chief broker at Principle Home Mortgage in State College.
“An FHA loan is sponsored by the Federal Housing Administration which is part of the HUD agency,” Whitteker says. “This loan is insured by FHA and banks or lenders will underwrite the loan according to the requirements and guidelines set forth by FHA. So basically, FHA sets the guidelines and will insure the bank or lender against loss as long as the loan is underwritten to the guidelines set by FHA.”
Why would a home buyer choose an FHA loan over a conventional mortgage?
FHA loans have the upper hand against conventional mortgages in a few areas. The main reason someone would choose an FHA loan over a conventional mortgage has to do with credit scores. FHA loans usually allow credit scores as low as 580. While it's never a guarantee, this allows individuals who are higher credit risks to be able to apply for a mortgage. Conventional loans usually require a credit score of around 620.
Do sellers have a preference between an FHA loan or a conventional mortgage
Each situation is unique. In a quiet housing market, sellers might not have many offers to choose from. Inside a competitive market like State College’s, there is a strong argument that sellers prefer conventional mortgages. FHA loans are typically more strict on the property being purchased and do come with a required appraisal contingency. FHA loans also require a water test if the property is on well water. Outside of this FHA is typically an easier loan to qualify for compared to a conventional mortgage.
Can I switch from an FHA home loan to a conventional loan before closing?
While it can be done, Whitteker says this situation is not one he commonly sees.
“This is possible but it is better to start with the home loan that you plan to use for closing,” Whitteker says. “In my experience this is quite rare. Typically, your mortgage provider will set you up with the correct lending product to begin with.”
Is it easier to get an FHA loan or a conventional mortgage?
It is in most cases easier to get approved for an FHA loan. FHA loans require lower credit scores and lower down payments. FHA loans typically look for credit scores above 580 while conventional loans require a credit score of at least 620. Further, FHA loans offer financing with as little as a 3.5% down payment. On the other hand, conventional loans might want as much as a 20% down payment.
Which one has a higher interest rate, an FHA or a conventional mortgage?
When basing numbers on the national average, interest rates appear lower on an FHA loan compared to a conventional loan. However, interest rates are variable and largely depend on your credit score. If you have a lower credit score, an FHA loan will be cheaper. Lower credit scores can lead to a higher monthly payment no matter which mortgage type you end up choosing.
According to Whitteker, the answer to this question is dependent upon different variables.
“This depends on factors like credit score and loan amount, but typically FHA will have a lower interest rate,” Whitteker says. “FHA does come with a higher mortgage insurance cost though.”
My debt-to-income ratio is bad. Would I be better off trying to get a conventional mortgage or an FHA loan?
If your debt to income (DTI) ratio is not ideal, you are better off applying for an FHA loan. FHA loans allow as high as a 57% plus DTI ratio, while conventional mortgages only allow up to a 50% DTI ratio. In any case, lowering your DTI is probably something to consider because it will also likely lower your credit score. Lowering your DTI can make you appear more credit worthy and open up more mortgage opportunities for you.
I don't have much money for a down payment. Is an FHA loan a better option for me?
While an FHA home loan’s down payment may seem more expensive at first Whitteker notes that the loan’s flexibility in closing costs can mean less money paid at closing.
“FHA will typically allow for less money out of pocket but this is due to the larger amount of allowable funds from the seller towards the buyers closing costs,” Whitteker says. “FHA requires a minimum down payment of 3.5% in most cases, while conventional actually has a 3% down option. The difference in out-of-pocket expense comes with the allowable seller assistance towards closing costs: FHA allows for up to 6% of the purchase price as seller assistance and conventional sets this limit to 3% of the purchase price.”
Can I refinance my conventional loan into an FHA loan?
Yes, it is possible to refinance a conventional loan into an FHA loan. Speak with your local mortgage broker to discuss the process.
Do I need more mortgage insurance for an FHA loan vs. a conventional mortgage?
You will be required to have mortgage insurance for an FHA loan no matter how much money you plan on using for a down payment. With a conventional loan, if you are making a down payment of more than 20%, mortgage insurance is not a requirement.
According to Whitteker, the answer to this can vary.
“Typically the answer to this question is yes, but the monthly mortgage insurance factor can actually be higher on a conventional loan depending on loan to value, credit score, and debt to income ratio.”
If you’re interested in learning more about FHA loans vs. conventional mortgages, contact the State College mortgage experts at Principle Home Mortgage at (814) 308-0959.
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