If you’re about to embark on the journey of buying your own house, you’re going to need to know what kind of loan options are available for you. Two of the most common types of loans are FHA and Conventional loans. They’re two very different loan options that first-time home buyers are likely to encounter. Here’s a small guide listing the difference between the two and which option would be best for you.
What is an FHA Loan?
An FHA loan is a government-backed home loan insured by FDA-approved lenders, including banks, credit unions, and other lending companies. This type of loan is intended for borrowers with limited savings or lower credit scores. Most lending institutions offering an FHA loan have less restrictive qualifications, which makes it a good choice if you don’t have that much money saved up for a down payment or have a not-so-stellar credit score.
Since these loans are federally insured, lenders can offer more favorable terms to borrowers who might not otherwise qualify for a typical home loan. This includes lower interest rates and more accessible qualifying standards.
What is a Conventional Loan?
On the other hand, a conventional loan is a mortgage loan that’s not guaranteed by a government agency. Compared to an FHA loan, they mostly required higher credit scores, lower debt-to-income ratios (DTI), and of course, down payment to qualify.
Conventional loans present the most risk for lenders since they’re not federally insured. They’re more designed for people with stronger financial profiles. You need to have a stellar credit score to qualify here. Most conventional loans come with fixed interest rates, which means the rate itself isn’t going to change throughout the life of the loan.
Credit Score and Down Payments
For an FHA loan, the typical credit score requirement is about 580, but it comes with strings attached. For example, you need to pay a 10% down payment to get an FHA loan with that credit score. Now, this isn’t set in stone as you can lower the down payment required the higher the credit score you have.
Conventional loans, however, have a somewhat different setup. While conventional loans are known to require a 20% down payment, they’re not actually a hard requirement. You can always pay less than that if you pay for private mortgage insurance (PMI). However, you still need to have a credit score of at least 680 to qualify.
A smaller down payment equals more risk, so you mitigate that risk for the lender when paying for mortgage insurance. PMI payments are built directly into your monthly mortgage payments.
Several factors affect the interest rates of both loan types. Most of the time, they are affected by the following high-level factors:
- Investor Demand
- The State of the Economy
- The Federal Reserve
These factors are mostly out of your control. Instead, focus on financial factors that control your credit score or DTI.
For FHA loans, interest rates can be competitive compared to conventional mortgages due to the government’s backing. It is also mainly affected by the amount you’re planning to borrow, your down payment, and of course, your credit score and income.
On the other hand, conventional loans are mostly based on your credit score and your loan-to-value ratio (LTV). This metric refers to the loan amount you’re planning to borrow relative to the property’s value that secures a loan.
In the end, it’s all about your ability to pay and your current financial situation. If you want something a little bit easier to pay, in the long run, a conventional loan is better, but it comes with steeper requirements. If you can’t satisfy those requirements, then an FHA loan might be more up your alley.
MyLendingPal is here to help you navigate the home buying process with ease. Work with our mortgage experts so you can review your options and choose the right type of home loan for your needs. If you’re looking for a good mortgage broker you can trust, MyLendingPal is the one to call. Contact us today to request a quote!