FHA Loans Q and A: How Do They Compare To Conventional Mortgages?

The choice between FHA and conventional home loans can be daunting for some first-time home buyers. What are the concerns between these two programs, and what does each one offer the borrower? We examine some of the key issues below in our question-and-answer session about FHA mortgages versus conventional loans.

Q: What's the biggest difference between FHA and conventional loans?

A: One of the most significant differences is the down payment requirement. FHA loans are known for their low down payment options, often as low as 3.5% of the purchase price. This makes them attractive to first-time homebuyers and those with limited savings.

Conventional loans generally require a larger down payment, typically ranging from 5% to 20% or even more. While some conventional programs offer low down payment options, they often have stricter qualifying criteria.

Q: I have a lower credit score. Can I still get a mortgage?

A: Possibly, with an FHA loan. FHA loans are generally more lenient with credit score requirements than conventional loans. While specific requirements vary by lender, the FHA often insures loans for borrowers with credit scores as low as 500, though a 10% down payment is usually required for scores below 580.

A credit score of 580 or higher usually qualifies you for the minimum 3.5% down payment. Conventional loans typically require higher credit scores, often 620 or above, with better terms available for scores above 680.

Q: What is mortgage insurance, and do I need it for both types of loans?

A: Mortgage insurance protects the lender if you default on your loan. Both FHA and conventional loans may require it, but the type and duration differ. FHA loans require two types of mortgage insurance premiums (MIP): Upfront MIP (UFMIP) and Annual MIP. UFMIP is paid at closing or added to the loan balance, while Annual MIP is paid monthly.

For most FHA loans originated after June 3, 2013, Annual MIP is required for the life of the loan. Conventional loans, when the down payment is less than 20%, typically require Private Mortgage Insurance (PMI). PMI is also paid monthly, but unlike FHA MIP, it can usually be canceled once you reach a certain equity position in the home, typically 20%.

Q: Are there limits on how much I can borrow with these loans?

A: Yes, both FHA and conventional loans have loan limits, though these limits differ. The FHA sets FHA loan limits and vary by geographic area, reflecting median home prices. Conventional loan limits, also known as conforming loan limits, are set by Fannie Mae and Freddie Mac and are also subject to geographic variation.

Q: What is a debt-to-income ratio (DTI), and how does it affect my loan approval?

A: Your debt-to-income ratio (DTI) is a measure of your total debt compared to your gross monthly income. Lenders use it to assess your ability to manage debt. FHA loans generally allow for higher DTI ratios than conventional loans. While specific guidelines vary, the FHA may insure loans with DTI ratios up to 43%, and sometimes even higher with compensating factors. Conventional loans typically prefer lower DTI ratios, often below 43%, and sometimes even lower for the best loan terms.

Q: Do FHA and conventional loans have different property requirements?

A: Yes, both have property requirements, but they differ in stringency. FHA loans have minimum property standards that must be met to ensure the safety, soundness, and sanitation of the dwelling. FHA appraisals are more thorough, focusing on these criteria.

Conventional loans also have property requirements, but they are generally less stringent. Lenders want to ensure the property is a worthwhile investment, but they may not be as strict regarding specific health and safety standards.

Q: Can I use an FHA loan to buy an investment property?

A: No. FHA loans are strictly for primary residences; they cannot be used to purchase investment properties. Conventional loans, on the other hand, can be used for investment properties. However, lenders typically require a larger down payment and may charge higher interest rates for these loans due to the increased risk.