FHA Vs. Conventional Loans For Mortgages 2023: A Full Guide
FHA Vs. Conventional Loans For Mortgages 2023: A Full Guide
by
December 23, 2022
Mortgage rates are expected to fall by the end of this year, leading many expectant homebuyers to wonder if now’s a great time to start planning for a mortgage loan.
Are you looking to purchase a more permanent home this year and are torn between FHA loans and conventional loans? We know it's not easy, as many factors go into getting the best mortgage, such as interest rates, down payments, and other fees.
Luckily, we're here to help make your decision easier. This comprehensive guide will dive into FHA vs. conventional loans for mortgages in 2023. We’ve laid out all pros and cons clearly so you can confidently choose the right option for your home.
Get ready to get informed on everything from credit scores to loan limits. It's time to let us guide you along your mortgage journey.
What Is An FHA Loan?
Simply put, FHA loans are government-insured loans. FHA mortgage loans are backed by the federal government and insure FHA lenders if the borrower defaults on their loan. This provides an added layer of security for lenders since they'll be eligible to recoup part of their losses through FHA insurance should a borrower not make their loan payments.
FHA mortgages also often come with lower rates, making them a more accessible option for those with less-than-perfect credit or who have difficulty securing traditional financing for a home purchase.
What Is a Conventional Loan?
A conventional mortgage loan is a home loan obtained from a private lender such as a bank or credit union, as opposed to being guaranteed by a government agency like the Veterans Administration or the Federal Housing Administration.
Because the government does not back them, these mortgage loans are somewhat harder to qualify for. To meet conventional mortgage qualification requirements, borrowers must typically have good credit scores and be able to provide proof of income and employment. For conventional loans, down payments can also vary significantly depending on the property type; these loans often require larger down payments than those provided by an FHA loan.
Likewise, it’s essential to know that there are two main types of conventional mortgage loans:
- A conforming conventional mortgage loan is a type of home loan that meets specific requirements laid out by Fannie Mae and Freddie Mac. These are what the finance world calls government-sponsored enterprises (GSEs). This type of conventional mortgage loan can be beneficial for those seeking a mortgage since lenders can sell conforming loans to one of the GSEs in the future, freeing up their finances so they can create new mortgages for other borrowers.
- A non-conforming conventional mortgage loan does not meet the requirements of Fannie Mae or Freddie Mac. This means the loan can not be sold to either GSE after closing, meaning more risk for the lender. For that reason, borrowers who go for non-conforming conventional mortgages usually have to demonstrate a higher level of creditworthiness to qualify.
Conventional vs. FHA: 7 Main Differences to Know
Aside from the basics of being government-backed or not, what is the main difference between FHA and a conventional loan? Scroll through the seven main differences between traditional vs. FHA for those looking for the best mortgage loan option.
1. Minimum Down Payment
An FHA loan is an excellent option if you're looking for a home loan and have excellent credit. It requires a minimum down payment of only 3.5% for borrowers with credit scores of 580 or higher, making it much easier to obtain than traditional mortgages.
For example, the minimum down payment for a conventional loan is usually at least 3% but can go even higher if you have poor credit. With traditional mortgages, borrowers typically need credit scores within the high 600s and ample savings to receive the same minimum down payment amount offered by FHA loans.
All things considered, FHA loans offer an accessible option for those who meet its credit score requirements.
2. Credit Score Requirements
As mentioned above, FHA loans are typically more accessible than conventional mortgages if you have a credit score lower than 580, as they require only a 3.5% down payment. Even with scores as low as 500 and 579, you may still be able to qualify for an FHA loan but with a higher 10% down payment requirement.
That being said, the credit score needed to qualify for a conventional loan will vary significantly from lender to lender, so it's best to inquire about the minimum credit scores required for either type of mortgage loan.
Generally speaking, higher credit scores will secure better interest rates on both FHA and conventional mortgages. So, it pays to learn how to boost your credit score as you work toward obtaining a mortgage loan this year.
3. Interest Rates
An FHA loan usually offers lower interest rates compared to a conventional loan. However, while FHA loans may come with more favorable interest rates, it’s essential also to consider the APR, which takes into account factors like processing fees.
This is important because even a mortgage with a lower rate might come with higher fees, making it cost more overall. The bottom line? To make an informed decision, it’s critical to research your mortgage loan options before settling on one to get the best overall value for your money.
4. Mortgage Insurance
If you don’t want to pay mortgage insurance, we don’t suggest opting for an FHA loan. However, do understand that mortgage insurance is an important measure to protect the lender in case of mortgage loan default.
What’s the difference when it comes to conventional vs. FHA loans? You must take out mortgage insurance on a conventional mortgage loan if your down payment is less than 20% of the sale price. With an FHA loan, you’re required to take out mortgage insurance regardless.
However, depending on your financial situation, a conventional loan might make more sense here for the following reasons:
- FHA mortgage insurance costs the same regardless of your credit score. This isn’t the case with conventional mortgage insurance.
- If you make less than a 10% down payment on an FHA loan, your mortgage insurance can last for the entire duration of your loan (yikes).
- The only way to get rid of FHA mortgage loan insurance is by refinancing to a conventional loan.
5. Loan Limits
Both conventional and FHA loans have a maximum loan size that varies depending on the county where your home is located. Likewise, regulators can adjust mortgage limits annually to safeguard consumers and lenders.
For example, the 2023 mortgage limit for standard FHA loans is $472,030 in low-cost areas, while it can reach as high as $1,089,300 in more expensive regions of the United States. On the other hand, the conforming mortgage loan limit for most of the US stands at $726,200.
What happens if you need to take out more than that? Mortgages that exceed that are called “jumbo loans” and require specialized terms.
6. Property Standards
Property standards for FHA and conventional loans differ, with FHA lending requiring more stringent property verification.
An FHA appraisal is a thorough property assessment that looks beyond the property's value, assessing safety, soundness of construction, and adherence to local code restrictions. When you get an FHA loan, you must use it to purchase a primary residence. This means that vacation homes and investment properties are not eligible.
Conventional loans have broader property use parameters; you can buy a primary residence, investment property, or even a vacation home with such a loan.
7. Refinancing
For refinancing, terms vary. Can you refinance an FHA loan to a conventional loan? For several reasons, refinancing an FHA loan into a traditional loan gives borrowers the edge.
Not only do you benefit from having no credit check, no income verification, and possibly no appraisal required, but it also allows you to get rid of monthly mortgage insurance payments in the long run.
The Pros and Cons of an FHA Loan
So which type of mortgage loan is best for you? Let’s break down some of the pros and cons of FHA loans to help make the decision easier.
Some reasons to go with an FHA loan over conventional loans include that FHA loans are better for those who do not have a large upfront payment or a perfect credit score. With an FHA loan, borrowers have more flexibility in making down payments and can benefit from a lower interest rate than those with alternative loan types.
However, one of the most significant drawbacks of an FHA loan is that it typically requires borrowers to purchase mortgage insurance, which can increase the overall cost of the loan. Additionally, some lenders view FHA loans unfavorably and may require additional documentation or proof of income before approval.
The Pros and Cons of a Conventional Loan
A conventional mortgage loan may be a good option for those in stronger financial positions since it typically requires higher credit scores, larger down payments, and lower debt-to-income ratios. However, these restrictions can mean fewer potential buyers qualify for this home loan.
Remember that although an FHA loan is advantageous in some instances, it comes with higher upfront costs and ongoing monthly insurance premiums, which can deter otherwise qualified buyers who are unable or unwilling to take on the additional financial responsibility.
Which Is Better: FHA or a Conventional Loan?
When it comes to FHA vs. conventional financing, how do you choose the best mortgage loan for your needs?
FHA loans offer a more lenient credit score requirement and a lower down payment but come with higher closing costs and vary in eligibility requirements.
Conventional loans, conversely, often require higher credit scores and higher down payments but may have more favorable interest rates and fewer restrictions in terms of eligibility requirements.
When making this decision, it's essential to consider the upfront and long-term costs of each type of loan, along with its advantages and disadvantages related to credit score or other factors. Ultimately you should choose the option that best meets your financial situation and goals.
Access Better Interest Rates With Cheers
Improving your credit score before applying for a mortgage loan is extremely important because a higher score can give you access to better interest rates and more favorable terms. It also improves your chances of getting the loan, especially when lenders take additional precautions due to current economic instability.
If you cannot qualify for the type of mortgage loan you want, whether an FHA loan or a conventional loan, we’re here to help. With our credit builder loans, you can safely and sustainably build your credit over time.
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