A Layman's Guide to FHA vs Traditional Loans

A Layman’s Guide to FHA vs Traditional Loans

Are you ready to buy a home?

One of your first thoughts is what type of mortgage you need. Conventional loans and FHA loans are two popular options for current homeowners who want to refinance a mortgage.

The main difference between the two is that an FHA loan is backed by the full faith and creditworthiness of the US government, whereas a conventional loan is not. But this difference is not over and is not limited to mortgages.

Here’s everything you need to know about an FHA vs a traditional loan.

Your Mortgage 

Choosing the right mortgage is important because the path you take can ultimately affect the cost of owning a home over the long term. Remember getting a government-backed loan isn’t wrong. It doesn’t make you responsible for any financial crash. Don’t let anyone tell you this is the main difference between an FHA vs a conventional loan.

It is possible that you can buy a home with a conventional loan or an FHA loan with the same amount of money but on different terms. FHA loans have long been touted as a go-go for homebuyers who can’t put aside a sizeable sum in cash. This is one of the key differences between an FHA and a traditional loan.

Down Payments 

Traditionally, a 20% down payment was the standard for conventional loans, but now it is possible to get a mortgage with an FHA loan for less than that or with no down payment.

Those who put less than 20 percent on a home with a conventional loan can apply for private mortgage insurance (PMI).

PMI is an insurance policy that allows them to recover financial losses if borrowers fail to service their mortgage. FHA loans are also privately insured and are referred to as “mortgage insurance premiums” (MIP).

Difference in Premiums

Traditional and FHA loans differ in the calculation and application of these premiums.

With traditional mortgages, you typically pay only a monthly or one-time premium for PMI, but with FHA loans, you have both an upfront premium and a monthly premium.

The upfront premiums can be transferred into the mortgage and repaid at the end of the term, and the monthly premiums are part of your mortgage payments.

The PMI is determined by the size of your down payment and credit value, as well as other factors such as your income, income level, and credit history.

Both conventional and FHA loans have a PMI that ends when you reach a credit-to-value ratio of 78%.

Getting Approval 

When you apply for an FHA loan, it’s a requirement that you will live in the house full-time. A home purchased under the FHA loan program must also meet strict valuation standards to qualify for a mortgage.

In that sense, a conventional loan may have fewer hurdles than an FHA loan, but it is still slightly more expensive.

A Layman's Guide to FHA vs Traditional Loans

Conventional and FHA loans use different standards for the borrower’s approval, and the down payment must be increased to 10% of the purchase price.

From the perspective of credit rating, FHA loans are easier to make and it is possible to obtain them without credit rating devaluation. Starting in 2018, the minimum score required for a Federal Housing Administration (FAA) loan is 580.

A score of 620 or better is generally recommended to qualify for a traditional mortgage, but individual banks may require an even higher score. Traditional lending has raised the bar for lending in recent years, particularly in the wake of the 2008-09 financial crisis.

Conventional mortgages typically limit acceptable DTIs to 43%, but FHA loans can be approved for those with a higher debt-to-income ratio (DTI). FHA loans generally offer borrowers better interest rates than traditional loans.

An FHA vs Traditional Loan? Have Your Pick

FHA loans and conventional loans are both good mortgage options, but they’ve some differences between them. With this FHA vs traditional loan guide, you now have the information you need to make a sound choice.

Interested in reading more about home loans? Be sure to check out the rest of our site.