Learning & Guidance | Skyla Credit Union

FHA Loans vs. Conventional Loans: What's the Difference?

Written by Yanna | Oct 12, 2022 12:00:00 PM

Are you in the market for a new home but not sure which mortgage option is right for you? Don’t worry - you're not alone!

In fact, it can be tricky to determine whether a Federal Housing Administration (FHA) loan or conventional mortgage loan is the best option for your needs. One can be more lenient than the other when it comes to qualifications, like having a lower credit score, lesser down payment, and more. On the other hand, one may be stricter than the other, like a requirement of an upfront payment and annual costs for mortgage insurance premiums, and the home you're financing has to be your primary residence.

The pros and cons of each type are different, so it's important to understand them before you decide which one is right for you.  Here, we'll break down each type and discuss the benefits and drawbacks of both!

here's a closer look at what we'll cover:

 

what's an fha loan?

Federal Housing Administration (FHA) loans are mortgages that are backed by the government. FHA loans are restricted by the U.S Department of Housing & Urban Development meaning they make the rules. Although FHA loans are backed by the government, your funds would go to the lender (financial institution) if you were to get an FHA loan. 

FHA loans were created to help low-income families become homeowners. They offer more flexible requirements like:

  • If you've had a foreclosure
  • Filed for bankruptcy
  • Have a low credit score

FHA loans aren't just for single-family homes. If you are thinking about financing a condo, 2, 3, or 4-family home, these loans can be an option to help you finance.

The loan can also be great recurring home buyers and 1st time home buyers but you have to remain at the residence immediately after closing and stay for at least one year.  

Since FHA loans have more flexible requirements, if approved, you'll be required to do an upfront cost of mortgage insurance premium (MIP).  Mortgage Insurance Premium is the amount that you must pay each month to have your interest rate guaranteed by an insurer. Lenders who have borrowers with an FHA loan use MIP to protect themselves from high-risk borrowers. Typically, the cost will be 1.75% of the loan amount. You have the option to roll the MIP cost into the financed loan amount.

Lenders require this coverage because they know some homeowners might not qualify for better rates elsewhere, but it's up in the air without these policies protecting their interests as well!

QUICK TIP: MIP can be waived after 11 years if you put at least 10% down payment for the loan and remained on time with your monthly mortgage payments. 

 

Another important piece to know about FHA loans is the maximum loan amount offered to families is different every year. In 2022, the maximum loan amount offered is $420,680. Some parts of the U.S may offer a higher maximum amount, but most of the United States has a maximum loan amount of $420,680.

Psst…  If you like to know the maximum loan amount offered in your state and county, you can find out on U.S. Department of Housing and Urban Development’s website here>.  

If you're considering an FHA loan, keep in mind that your debt-to-income (DTI) ratio needs to be no higher than 43%. to be eligible for the loan. Your DTI tells lenders what you owe compared to what you earn. 

QUICK TIP: If you like to calculate your DTI, here's a calculator that will help. 

If you like to do the math yourself, simply add up your minimum monthly payments (rent, student loan, credit card, auto loan, etc.). Then divide your monthly payments by your gross monthly income. Make sure you change the decimal to a percentage.  Voila, there you have it!  

 

HOW TO QUALIFY FOR A FHA LOAN?

If you're interested in getting an FHA loan, here's what you'll need to qualify:

  • Credit score 500 - 579 but you have to make a 10% down payment; or
  • Credit score of 580 + with a 3.5% down payment. (the greater the credit score the less of a risk the lender will see you as).
  • A debt-to-income (DTI) ratio generally needs to be 43% or less. 
  • Employment History (past two years)
  • Verifiable income(pay stubs, bank statements, tax returns, etc.)
  • Mortgage insurance premium 
  • The home must be appraised by an FHA-approved appraiser 
  •  FHA inspection requirement. The inspector needs to report the property meets standards. 
  • The home you're seeking an FHA for must be your primary residence (Psst... not a second home.)
  • The property must be occupied within 60 days of closing. 
QUICK TIP: Although I've shared the credit score requirements, different lenders are allowed to set their own requirements for FHA loans.  If you're seriously interested in getting an FHA loan, make sure you talk to a lender. 

If your credit score is below 580 or you're concerned you may not get approved for a great interest rate due to a low credit score, here are some tips that will help you in your journey to improving your credit health. 

 

fha advantages and disadvantages

[faq1]

 

WHY DON'T SELLERS LIKE FHA LOANS?

Mortgages loans that are insured by the Federal Housing Administration (FHA) have been growing in popularity in recent years. However, some sellers are reluctant to accept offers from buyers who are financing their purchase with an FHA loan. There are a few reasons for this.

First, FHA loans typically require a higher down payment than other types of loans. This can make it difficult for buyers to come up with the necessary cash. Additionally, sellers may be concerned about the extra paperwork and delays that can occur when working with an FHA loan. Lastly, FHA loans typically have stricter standards for property conditions, which can mean that a seller will have to make more repairs before listing their home. 

Despite these challenges, all sellers are not against FHA loans. There are still many reasons why sellers may choose to accept an offer from a buyer who is using an FHA loan. For example, FHA loans usually have lower interest rates than other types of loans, meaning that the buyer will save money over the life of the loan. Additionally, FHA loans are available to a wider range of buyers, including first-time homebuyers and those with less-than-perfect credit. In the end, it’s up to the seller to decide whether they’re willing to work with a buyer who is using an FHA loan.

 

what's a conventional loan?

Conventional mortgages not insured or guaranteed by the government.  This means that if you cannot make your mortgage payments, you will not be able to get help from the government as you could with a Federal Housing Administration (FHA) loan.

Conventional mortgage loans are backed by private agencies, [tooltip1].   These agencies buy mortgages from lenders and sell them to investors. This helps to ensure that lenders will continue to offer these loans, as they know that there is a market for them.

Conventional mortgages are great if you have a good or excellent credit score (620+). If you have a lower credit score, you may still be able to get a conventional mortgage loan, but you may have to pay a higher interest rate.

The cool thing about conventional loans is that you're not required to pay Private Mortgage insurance (PMI) if you make a 20% down payment. You're also not required to make the property your primary residence.  You can use a conventional loan to purchase investment properties. So, you could rent the location and live elsewhere as your primary location if you wanted to.  

Not all lenders require a down payment with conventional mortgages.  If it is required (depending on the lender) private mortgage insurance is needed if the down payment is below 20%.

 

how do i qualify for a conventional loan?

If you're interested in getting a conventional mortgage loan, here's a look at Skyla's requirements to get an idea of what you'll need to qualify.

  • Typical credit score is 620 +. Psst...  Depending on the lender, you may get approved for a conventional mortgage with a lower credit score but this depends on the lender. At Skyla, options are available for those with limited credit history. 
  • Debt-to-income (DTI) ratio is no higher than 45% Psst... this is the case for borrowers seeking a conventional loan at Skyla. In other words, your debts take up no more than 43% of your gross monthly income. For nonconforming loans, DTI of up to 50%. 
  • Proof of income (30 days of your most recent paystubs)
  • W2s (2 years of your most recent W2s )
  • 60 days of bank statements if you're coming from another financial institution. 
  • Two most recent years of tax returns if you’re self-employed 
  • Additional verification information (auto loan, credit card, most recent retirement account statement)

At Skyla, our mortgage professionals can help you decide if a conventional mortgage loan is the right choice for you. We offer a variety of conventional loans, so we can find the one that best fits your needs.

Both FHA and conventional loans have their limits on the maximum amount a borrower can borrow. Since conventional loans are not backed by the government, the maximum amount varies by lender. 

 

conventional mortgage loan advantages and disadvantages

[faq2]

 

about skyla mortgage options 

Unfortunately, we don't offer FHA loans BUT but we do offer conventional loans. Our Welcome Home Loan was crafted with you in mind:

  • No Private Mortgage Insurance (PMI) required
  • Skyla pays your Appraisal, Credit Report, and Flood Certification fees
  • Options for those with limited credit history
  • 30-year fixed-rate term. Fixed-rate terms up to 30 years.
  • No prior homeownership within the last 12 months
  • Most property types approved
  • Closing Costs can be paid by the seller

 

 

which mortgage option is right for me?

It's possible to qualify for both loan types. But when deciding which option is right for you, ask yourself, "what would work for you and your financial needs? Since everyone's financial situation is different, here are some more starter questions to ask yourself to help.

  • Are you looking to save money?
  • Which mortgage option offers a better interest rate?
  • What are the closing costs?
  • Have you found a suitable home? Do you plan to make the home your primary residence?
  • Are you prepared if the seller declines your offer if you went forward with an FHA loan?

Since all borrowers are not in the same situation,  It always helps to weigh out the pros and cons to see what'll work best for you. 

If you just need to speak to someone to compare both offers, we'll be happy to help. Our Mortgage Loan Officers are here for you. You can send an email, give us a call at 704.375.0183 x 1525, or visit any of our branches