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Conventional vs. FHA – Important Differences

Conventional mortgage loans are mortgages that are not “guaranteed” by the Federal government. An FHA mortgage is a loan that is “guaranteed” by the federal government. Conventional loans are more common than FHA. Both loan programs have their benefits and their downsides.

Use our guide below to help you discover the benefits of both loan programs. Once you have a better understanding of conventional vs. FHA mortgages you’ll be in a good position to find the right mortgage for you.

Deciding on Conventional mortgage vs. FHA mortgage

Conventional Mortgage

Most loans are Conventional loans, and most Conventional loans are Conforming loans. Some Conventional mortgage loans require a higher credit score, and in some cases asset reserves.

What is Conventional Mortgage? 

According to Investopedia;

A conventional mortgage or conventional loan is any type of home buyer’s loan that is not offered or secured by a government entity. Instead, conventional mortgages are available through private lenders, such as banks, credit unions, and mortgage companies. However, some conventional mortgages can be guaranteed by two government-sponsored enterprises; the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac).

source: investopedia.com

Conventional mortgage loans can have either a fixed-rate or an adjustable-rate (adjustable rate mortgages usually have a “fixed period” of 3, 5, 7, or 10 years. After the fixed period your rate adjusts to current market conditions which are the index your loan is based on and a predetermined margin).

Conventional loans can be used for primary residences, second homes, and rental properties (1-4 units). For those homeowners or homebuyers that pursue a conventional conforming mortgage loan; limits for conforming mortgage loans were raised in 2019, 2020, and 2021.

If you are shopping for a home, it is crucial to find a mortgage that suits your needs as it is vital to find a suitable residence. This is because there is no all-in-one solution when it comes to lending. Your budget rating and credit rating are a determinant in choosing the right mortgage for you. One of the best mortgages, if you have a low debt ratio, is a conventional mortgage. 

Benefits of a Conventional Mortgage 

The following are why a conventional mortgage could be the best option for your home purchase decision. 

Low Rates, Fast Process And More Options: 

Conventional mortgages come with low rates; especially for those with above-average credit and excellent credit.

30-year fixed mortgage rates and 15-year fixed mortgage rates tend to be the most common rates homeowners chose. However, at times, adjustable-rate mortgages tend to be more attractive.

With the exception of the FHA Streamline Refinance Conventional mortgages generally close faster; especially applications that receive an appraisal waiver.

With Conventional mortgages you have lots of options, low down payments, five main fixed rate programs and three main adjustable rate programs, appraisal waivers and more.

Avoid Mortgage Insurance (MI): 

With a conventional mortgage, you can save on Mortgage Insurance if you have at least a 20% downpayment.

FHA loans require homeowners to pay monthly Mortgage Insurance (MI). Even if you put 20% or more down.

Conforming Mortgage Loans:

In the category of Conventional mortgage loans is conforming mortgage loans and Non-Conforming mortgage loans. Conforming mortgage loans are mortgages that adhere to the underwriting guidelines set forth by mortgage giants Fannie Mae and Freddie Mac.

The increasing loan limits are good news for homeowners in California due to our higher home prices. For some their current mortgage is no longer a “Jumbo” mortgage (lower rates, easier to qualify for) and for others, it might allow them to now buy that home since their loan amount is now a conforming loan amount.

Fannie Mae and Freddie Mac have been granting more appraisal waivers with their approvals which has been an added bonus for California homeowners.

Mortgage loans that fall outside of those guidelines are considered non-conforming. So you can have a Conventional Conforming mortgage loan or a Conventional Non-Conforming mortgage loan.

FHA Mortgage

The purpose of the FHA mortgage loan program is to assist homebuyers and homeowners get qualified for a new mortgage who might otherwise struggle to obtain a conventional conforming mortgage loan.

Suppose you lack a substantial credit card history to secure financing or are a first-time home buyer. In this case, you probably might have difficulty coming up with the required large down payment for a conventional mortgage. 

However, the Federal Housing Authority (FHA) loan is backed by the government and offers less strict requirements. It has made house buying more accessible for people with a credit rating starting at 580 and a down payment of 3.5%. 

The Benefits Of An FHA Mortgage

Here are the benefits of an FHA mortgage. 

Lower Down Payment and Credit Score: 

FHA requirements for credit score and down payment is much lower the Conventional mortgages. If a borrower has a credit score of 580 and a down payment of 3.5%, you might be able to qualify for an FHA loan (some lenders require a 600 or higher credit score). 

In fact, FHA allows for no credit score. Under the FHA program, applicants can use nontraditional credit as an alternative.

FHA Mortgages Are Assumable: 

If you sell your home the buyer can take over your existing FHA mortgage.

So if your FHA mortgage rate is at 3.5% and current mortgage rates are higher then this benefit could really help you locate a buyer for the home. It’s important to check with the lender about the requirements before you list your home for sale.

A Higher Closing Cost Credit Allowed: 

Under the FHA loan program the seller can pay up to 6.00% of the loan amount towards closing costs (Conventional is generally limited to 3%).

This means if you are struggling to come up with enough money for closing costs then the FHA program would really help your situation.

FHA Mortgage Guidelines:

FHA mortgage guidelines are a bit more flexible in certain areas and are used to either purchase a primary residence or refinance the mortgage attached to a primary residence.

General requirements are for at least a 580 credit score and 3.5% down or equity in the home (if you are doing a refinance). Very few lenders (in 2021) will go below a 580 credit score even though FHA guidelines allow for it.

FHA mortgages carry lower interest rates than conventional conforming mortgage loans however FHA mortgages carry Mortgage Insurance (MI) which is an added cost to the homeowner. Mortgage Insurance (MI) is an insurance policy you pay each month with your mortgage payment to cover the cost of insuring your mortgage.

The insurance is in place in case you default on your loan. If you default the Federal Government will cover the cost and reimburse the mortgage lender for any losses associated with the default.

Some conventional conforming loans have Private Mortgage Insurance (PMI) which is similar to MI however that is only required if there is less than 20% equity in the home (or if your down payment is less than 20%).

The FHA mortgage loan program offers a “streamline” option for refinancing; no appraisal is needed and borrowers can close fairly quickly if rates are below their current rate.

Conventional vs. FHA – Which One Is Better?

It depends on the individual person. If you have a credit score above 740 and a good sized down payment the FHA loan program might not be for you unless you are looking to purchase a home (or refinance) that needs work.

The FHA 203(k) loan program is one of the best loans out there and it’s even a great option for those with excellent credit.

Essentially it’s two loans in one; a loan to purchase the property and loan to repair/remodel the property. All one loan, one lender and one application.

If you have a sub 680 credit score and/or a small down payment you may want to focus on the FHA loan program especially if you are a First Time Home Buyer.

When it comes to deciding which loan program is better the best thing you can do is talk with your Loan Officer and discuss your different options.

Lowest Mortgage Rate

Obtaining the lowest mortgage rate for a conventional or non-conventional mortgage loan, such as an FHA loan, is something every homeowner hopes for when they purchase a home or refinance a current mortgage. Working with a top-rated mortgage company will help ensure you receive the lowest mortgage rate at the best possible terms.

If you chose to work with a mortgage company that has a bad reputation and/or a bad rating with the Better Business Bureau you are taking a serious risk with one of the most important financial transactions you’ll ever take.

Loan Officer Kevin O'Connor

About The Author

Loan Officer Kevin O'Connor has over 16 years of experience as a Mortgage Loan Originator and is licensed with the state of California and the Nationwide Mortgage Licensing System. He has a top rating with the Better Business Bureau, Google, Yelp, and Zillow. CA DRE #01499872 / NMLS #247447

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