What’s the difference between conventional and FHA mortgage loans?
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UPDATED: Jul 30, 2012
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There are several notable differences between conventional and FHA home loans, but the primary difference between a conventional mortgage and an FHA mortgage is that one type is backed by the government whereas the other is not.
FHA home loans, which refer to financing that is backed by the Federal Housing Administration, is secured by the government. Because of this, these loans tend to be more accessible to a broader spectrum of people. However, FHA loans don’t always come with the best terms.
In order for borrowers to determine whether a conventional home loan or an FHA home loan is right for them, they should start by asking themselves the following questions:
- Can I afford a large down payment?
- Would I mind paying private mortgage insurance (PMI)?
- What kind of a credit score do I have?
The Down Payment Size and Possibility of PMI
The size of a homeowner’s affordable down payment will be one of the largest deciding factors in what type of mortgage to finance.
Conventional mortgage loans typically require a homeowner to put a full 20 percent down.
FHA home loans allow homeowners to get away with putting down just 3.5 percent.
However, there’s one caveat to the FHA’s low down payment requirement: PMI.
PMI is a way for mortgage securers (in this case, the government) to protect themselves. PMI is an additional annual cost to homeowners that usually equates to roughly 0.5 percent of the total value of their property.
So a homeowner with an FHA mortgage for a $200,000 home can expect to pay an additional $1,000 per year for PMI.
Credit Score Expectations
Credit scores and financial history have long been used by lenders to gauge their risk in conducting business with borrowers. Typically speaking, the higher a borrower’s credit score, the less risky that borrower is. And the less risky a borrower is, the more likely they will qualify for a loan.
Since conventional mortgages are originated and secured by individual lenders, they usually require good to excellent credit scores.
On the other hand, since FHA loans are backed by the government, they remove a substantial amount of risk from lenders. As a result, even borrowers with low credit scores can qualify for an FHA mortgage loan.
So Which One?
Borrowers need to look at their specific situation to determine whether FHA or conventional financing is right for them.
As a general rule of thumb, use the following advice:
- Conventional home loans are great for those with good credit and a substantial amount of money for a down payment.
- FHA financing is better for those with poor credit or not a lot of money reserved for a down payment.