FHA vs. Conventional Loans: Which One is Better?

With so many choices for home financing, it’s no wonder shopping for a mortgage is stressful and confusing. There are dozens of loan products on the market, and you deserve information before making such a big commitment. The good news is that there’s a home financing solution for almost everyone, whether you have good credit, bad credit or no credit at all. Read on for a comparison of conventional and FHA loans.

When You Should Get a Conventional Mortgage Loan

Conventional loans come in two varieties: conforming and non-conforming. The guidelines, loan amounts and criteria are set by Fannie Mae and Freddie Mac. With a conforming loan, the borrower must meet the minimum credit score of 640, and scores over 720 will typically get a lower interest rate. If you put more than 20% down, you’ll escape the mortgage insurance requirement.

Both types of loans can be repackaged and sold as securities on the secondary market. The main difference between the two is that a conforming loan has a cap for the upper loan amount, and non-conforming loans can go above that cap. However, you may end up paying a higher interest rate.

Conventional loans are for those with good credit and a large down payment who want to buy in a more expensive area.

When an FHA Loan Is Better

Federal Housing Authority loans are backed by the federal government. Because they are guaranteed, lenders can afford to take a risk with those who have bad or slow credit; a credit score of 580 is the standard. The advantages of FHA Loans include lower down payment requirements of as little as 3% in addition to lower interest rates. Buyers can even borrow the down payment from a relative, which you can’t do with a conventional loan.

On the downside, there’s a cap on FHA loans that averages about $271,000 depending on your location. That means you may be priced out of certain neighborhoods. You’re also required to carry mortgage insurance for the first five years of the loan period, which might temporarily cancel out the lower payments and interest rate.

FHA loans are a great option for buyers with low incomes or bad credit.

So, which type of loan is better? In the end, it depends on your financial situation and how much risk you and the lender are willing to take. When you’re ready for the next step, find out if you qualify for an FHA loan.