Buying a home involves a lot of important decisions. In addition to finding the right property in a suitable location at a reasonable price, homebuyers need to decide on the right type of financing to make the purchase possible. One question many borrowers struggle with is whether they should get an FHA loan or a conventional one.
Factors To Consider When Choosing Between An FHA Or Conventional Loan
An FHA loan is insured by the Federal Housing Administration, whereas a conventional mortgage is not insured by a federal agency. A common misconception is that FHA loans are reserved for first-time buyers. Both of these loan types can be advantageous to any type of buyer, but the requirements to quality for the loans can differ.
Below is a closer look at some of the factors that borrowers should consider when deciding whether an FHA loan or a conventional one is the better choice.
Your Credit Score
To qualify for a conventional loan, a borrower typically needs a credit score of at least 620. It may be possible to get a conventional loan with a lower credit score, but the borrower will likely have to pay a higher interest rate.
In general, it is easier to qualify for an FHA loan. To be eligible for a 3.5-percent down payment, a borrower needs a credit score of at least 580. Those with credit scores between 500 and 579 might qualify for an FHA loan if they can make a 10-percent down payment.
Minimum Down Payments
An FHA loan requires borrowers with a credit score of 580 or higher to make a minimum down payment of 3.5 percent. In contrast, some conventional mortgages might allow a down payment of 3 percent if a borrower has plenty of savings and a credit score in the high 600s.
Your Debt-To-Income Ratio
Another important factor is your debt-to-income ratio, or DTI. This figure represents the percentage of your monthly pre-tax income that you need to cover all your debts, such as student loans, car loans, child support, mortgages and minimum credit card payments. Those with a higher DTI are more likely to have trouble paying their bills and represent a greater risk to the lender.
To qualify for an FHA loan, your DTI cannot exceed 50 percent. While lenders may sometimes allow a DTI closer to 50, those whose DTIs are under 43 are far more likely to be approved.
Mortgage Insurance Requirements
Mortgage insurance requirements are a big consideration when determining which type of loan is best. This insurance will protect the lender if the borrower defaults on the loan.
Mortgage insurance is always required with an FHA loan, and the premium will not be affected by a borrower’s credit score. FHA mortgage insurance premiums will last for the duration of the loan for those who make a down payment that is less than 10 percent. However, refinancing to a conventional loan can end this requirement.
With a conventional loan, a borrower is required to take out mortgage insurance if they make a down payment of less than 20 percent. Private mortgage insurance is generally more expensive for those with a low credit score, although it can end up being cheaper than mortgage insurance on an FHA loan for those whose credit scores are greater than 720. Private mortgage insurance will be canceled automatically on a conventional loan once the equity reaches 78 percent of the home’s purchase price.
The costs of the insurance vary depending on the size of the down payment with both private mortgage insurance and FHA mortgage insurance.
Both types of home loans place a limit on the amount of money people can borrow, and this can vary depending on the county of the residence. In 2020, the limit for FHA loans in low-cost areas is $331,760; this climbs to $765,600 in more expensive markets. Conventional loans must adhere to the conforming loan limit that is set by the Federal Housing Finance Agency. The limit in 2020 is $510,400 in most of the country; those that exceed this amount are considered jumbo loans.
Refinancing is one of the areas in which FHA loans shine. An FHA streamline refinance does not require a credit check or income verification; in many cases, no home appraisal will be needed.
Some borrowers opt to refinance an FHA loan to put an end to monthly mortgage insurance payments. Homeowners who made a down payment of less than 10 percent are required to make these payments, but once they have accumulated 20 percent in equity, they can avoid them by refinancing into a conventional mortgage.
Learn More From An Experienced Mortgage Brokerage
A home loan is a major commitment that will require ongoing payments for many years, so it is essential to discuss the available options with experts in the field before making a decision. If you are interested in learning more about the best type of home loan for your particular financial situation, get in touch with the experienced mortgage brokerage at MyLendingPal.