FHA vs. Conventional Loans
May 26, 2021
FHA vs. Conventional Loans
The two most common types of mortgage loans are Conventional and FHA. While similar, some key differences set them apart.
Down Payment and Loan-to-value (LTV)
A down payment is the amount of money you put towards the purchase price at the start of a loan. When it comes to down payments, Conventional and FHA loans differ in subtle but important ways.
For a Conventional loan, first-time homebuyers can put down as little as 3% of the purchase price. For everyone else, the minimum is 5%. If you put down less than 20%, you will be required to pay private mortgage insurance. More on that later.
FHA loans allow borrowers to put down as little as 3.5%.
LTV is the inverse of your down payment. It lets you know what percentage of your home’s value is covered by your loan. This means that your down payment and LTV should always add up to 100%, making the two closely linked!
Following that math, if you’re a first-time homebuyer and your Conventional loan down payment is 3%, then your LTV will be 97%. If it’s not your first time purchasing a property, your maximum LTV will be 95%. FHA borrowers putting the minimum down payment will have an LTV of 96.5%.
When you think about the term insurance, you think of security and protection. That’s what mortgage insurance is. It protects the lender from the possibility of the borrower defaulting on their loan.
Depending on your loan type, you might be required to take out private mortgage insurance (PMI) or mortgage insurance premium (MIP) on your loan.
Conventional loan borrowers who put down less than 20% upfront are likely required to get PMI. There are plenty of reasons you might want to go this route. Maybe you want a little more cash in your pocket to furnish your new house or for renovations. PMI payments differ depending on the borrower and are based on your down payment, credit score, and other financial factors. However, they are manageable and automatically included in your monthly payment. Once Conventional borrowers reach 20% equity, they can apply to remove their monthly PMI payment. In some cases, servicers will do this automatically.
Alternatively, most FHA loans require MIP. This usually includes an upfront MIP and annual premium, despite the size of the down payment. Your MIP is paid in monthly installments that are rolled in with the rest of your payment. If you put 10% or more down on an FHA loan, your MIP payments stop after 11 years. Otherwise, they continue for the lifespan of the loan.
Credit scores indicate your history as a borrower and play a role in determining which kind of loan is best for you.
At UMortgage, a credit score of 640 or above is required to be approved for a Conventional loan. While FHA loans can allow people with credit scores in the 500’s to get a loan, UMortgage requires a credit score of at least 620. If you are worried about meeting our credit score minimums, don’t worry! Our credit coaches are ready to help you bolster your credit and get you ready in no time. If your time frame is a little tighter, let us know and we will refer you to one of our trusted partners.
Upfront Mortgage Insurance Premium (UFMIP)
UFMIP is a one-time charge that can be paid upfront or rolled into the total loan amount. Conventional loans do not require UFMIP. Alternatively, the funding fee for an FHA loan is 1.75% of the loan amount.
Debt-to-Income ratios give lenders an insight into how much of a borrower’s monthly income is allocated to paying off debt.
Conventional borrowers are permitted to have DTIs up to 45% with some room to move up to 50% depending on the financial stability of the borrower. FHA borrowers may have DTIs up to 50%. Similar to credit scores, FHA borrowers are allowed to have a higher DTI because of the protection the lender has through their PMI.
Borrowers can utilize Conventional loans for a primary residence, secondary residence, and investment properties. FHA loans cannot say the same. FHA loans are only allowed to be used for primary residences.
In addition to property type limits, there’s a ceiling for how much money can be borrowed for each type of loan.
The limit for Conventional borrowers varies by county and caps out at what is considered a higher loan amount for the area. For example, the Conventional loan limit in San Francisco, CA for a one-unit residence is above $800,000. Alternatively, it’s less than $600,000 in Oklahoma City for the same criteria. If you’re looking for a loan above your regional limit, you will need to shop around for Jumbo loans instead.
The limit on FHA borrowers differs county by county as well. The FHA loan limits range for 2021 goes from around $360,000 to a little over $800,000.
Remember, these limits are adjusted on a yearly basis. Chat with one of our team members today about the loan limits in your area!
Refinance Seasoning Period
A refinance seasoning period is the amount of time that needs to pass between closing on a loan and refinancing that same loan. Conventional loans can typically be refinanced at any point after closing, with the exception of a cash-out refinance which requires a 6 month seasoning period. Some Conventional lenders won’t do immediate refis no matter the loan type, so be sure to check on those requirements prior to starting the process. FHA loans require a 12-month seasoning for cash-out refis and 7 months non-cash-out refis.
Which is right for you?
In the end, there are many differences between FHA and Conventional loans. Ultimately it comes down to what you want from your loan. There is no “better” or “right” option. It all depends on where you’re at in your homeownership journey. Luckily, UMortgage is always here to help you weigh the pros and cons and make an intelligent choice.