FHA Versus Conventional Mortgage
Author: Woodsboro Bank
When financing the purchase of a home, borrowers can choose between FHA and conventional mortgages. FHA loans are ones issued by the Federal Housing Administration, while conventional mortgages are from a lending institution such as a bank. Each of these options has a different set of requirements. Here is a look at what sets them apart.
What Is An FHA Loan?
FHA loans are mortgages that are federally insured and issued by lenders that have been approved by the Federal Housing Administration. They may be available through credit unions, banks, or other lending companies and are intended for borrowers who have lower credit scores or limited amounts of savings.
They may be used to purchase or refinance a single-family home, condo, or multifamily home with up to four units. The fact that these homes are federally insured means that lenders may be able to offer more favorable terms, such as lower interest rates, to borrowers who could not qualify for a mortgage otherwise, making these loans easier to qualify for than their conventional counterparts.
What Is A Conventional Mortgage?
Conventional loans, meanwhile, are mortgages that are not backed by government agencies and are serviced and originated by a private mortgage lender such as a credit union or bank. These loans present the greatest risk to lenders, which means they typically look for applicants who have stronger financial profiles, including an excellent credit report.
How Do They Differ?
Both types of mortgages have pros and cons. Here is a closer look at how these mortgages differ when it comes to several important considerations when purchasing a home.
Minimum Down Payment
One way in which these two types of loans vary is in the required minimum down payment. For individuals with a credit score 580 or higher, the required down payment on an FHA loan is three and one-half percent, while those with credit scores in the 500-579 range are required to pay 10 percent.
With conventional mortgages, first-time home buyers may be able to pay a down payment as low as three percent. However, they will be responsible for paying mortgage insurance if they cannot put down at least 20 percent on the home. For those who are not purchasing their first home and earn less than 80 percent of the median income in the area where the home is situated, the lower limit is five percent.
Debt-To-Income (DTI) Ratios
A debt-to-income ratio compares an individual's income with their debts. This ratio is considered by lenders to determine whether you can comfortably afford to take on a monthly mortgage payment.
You can determine your debt-to-income ratio by adding up fixed monthly expenses such as your rent or mortgage payment; your minimum monthly payments for credit cards, car loans and other loans; and recurring fixed costs such as alimony or homeowners’ association fees. This total is divided by your gross monthly income to determine your DTI.
Most conventional and FHA mortgages require a DTI of 50 percent or less; for an FHA loan, your DTI ratio cannot be higher than 45 percent if you have a credit score that is under 580.
Both types of mortgages place a limit on the amount of money that a person can borrow. The limit for FHA loans in 2022 was approximately $420,000 for homes in low-cost areas and $970,000 for homes in higher-priced markets; this is adjusted regularly. Meanwhile, conventional loans must adhere to the limits outlined by the Federal Housing Finance Agency. This was around $647,000 for most of the US in 2022.
In some cases, borrowers may be required to pay mortgage insurance, which is a form of protection for the lender in the event that you stop making payments.
With an FHA mortgage, mortgage insurance premiums are mandatory regardless of the amount of the down payment. This is an upfront payment that may be rolled into the loan itself and paid throughout the course of the loan as well as monthly premiums. The length of time it must be paid depends on the down payment; those who put down at least 10 percent must pay mortgage insurance premiums for 11 years, while those whose down payment is below 10 percent will have to make mortgage insurance premium payments throughout their mortgage.
The rules are slightly different with a conventional mortgage. Only those borrowers who put down less than 20 percent on their loan will be required to pay private mortgage insurance. When their mortgage balance drops to 80 percent of the home's original value, which is either the appraised value when it was purchased or the contract sales price, they can ask their lender to cancel private mortgage insurance. Otherwise, the lender is required to remove it when the balance reaches 78 percent.
Contact Woodsboro Bank
For assistance determining the right type of mortgage to suit your financial situation and achieve your home-buying objectives, reach out to the friendly mortgage team at Woodsboro Bank. Serving our community since 1899, we are dedicated to providing customers with a true community banking experience.