FHA Loans 101
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FHA loans allow lower credit scores than conventional mortgages do, and are easier to qualify for.
Let’s see, FHA loans are for first-time home buyers and conventional mortgages are for more established buyers — right?
FHA loans are insured by the Federal Housing Administration and conventional mortgages aren't insured by a federal agency. Both types of loans have their advantages for any type of buyer. Here are the factors to consider when deciding between an FHA loan and a conventional mortgage.
» MORE: Summary of FHA loan requirements
FHA loans have a minimum down payment of 3.5% for borrowers with credit scores of 580 or higher. Some conventional mortgages have a minimum down payment of 3% but require a credit score of 660 or 680, depending on how much you have left in savings after you close the loan.
Credit scores and mortgage rates
FHA loans are easier to qualify for, with a minimum credit score of 580 to be eligible to make a 3.5% down payment. If your credit score is 500 to 579, you may qualify for an FHA loan with a 10% down payment.
Conventional loans typically require a credit score of 620 or higher, says Joe Parsons, a senior loan officer with PFS Funding in Dublin, California. He adds that a lower credit score often comes with a higher interest rate for a conventional loan.
Your debt-to-income ratio, or DTI, is the percentage of your monthly pretax income that you spend to pay your debts, including your mortgage, student loans, auto loans, child support and minimum credit card payments. The higher your DTI, the more likely you are to struggle with paying your bills.
Your debt-to-income ratio must be 50% or less to qualify for an FHA loan. Conventional loans allow debt-to-income ratios up to 50% in some cases, too. Even though lenders allow debt-to-income ratios that high, approval is more likely for mortgage borrowers with DTIs of 43% or less.
» MORE: Best lenders for FHA loans
With a down payment of less than 20%, both FHA and conventional loans require borrowers to get mortgage insurance that protects the lender in case of default. The differences are:
FHA premiums cost the same no matter your credit score. Private mortgage insurers charge more if you have a low credit score.
FHA mortgage insurance premiums last for the life of the loan if you make a down payment of less than 10%. You can get rid of FHA mortgage insurance by refinancing to a conventional loan. By contrast, private mortgage insurance is automatically canceled after your equity reaches 78% of the purchase price.
Both FHA and private mortgage insurance costs vary according to the size of the down payment.
Both conventional and FHA loans limit the amount you can borrow, and the maximum loan sizes vary by county. Regulators may change the loan limits annually. The FHA upper limit in 2019 is $726,525 for single-family homes in high-cost markets.
» MORE: Details on FHA loan limits
When you get an FHA loan, you have to live in the house as your primary home. Investment properties and homes that are being flipped (sold within 90 days of a prior sale) aren’t eligible for FHA loans.
You can use a conventional loan to buy a vacation home or an investment property, as well as a primary residence.
FHA appraisals are more stringent. Not only is the property assessed for value, it is thoroughly vetted for safety, soundness of construction and adherence to local code restrictions.
As far as mortgage refinancing goes, the edge goes to FHA “streamline” refinancing. With no credit check, no income verification and likely no home appraisal, it’s about as easy a refi as you can get. But there are five strict requirements for an FHA streamline refinance.
There's another reason to refinance an FHA loan: to get rid of the monthly mortgage insurance payments. FHA mortgage insurance can't be canceled if you made a down payment of less than 10%. To get rid of the monthly FHA premiums after you have accumulated 20% equity, you have to refinance into a conventional mortgage.
Deciding between the two
FHA and conventional mortgages have a few differences:
Conventional loans allow slightly smaller down payments, have lower mortgage insurance payments for borrowers with credit scores of 720 or higher and have more liberal property standards. Private mortgage insurance on conventional loans may be canceled.
FHA loans are available for borrowers with credit scores lower than 620, and FHA monthly mortgage insurance premiums are lower for borrowers with credit scores under 720. In most cases, you can't get rid of FHA mortgage insurance unless you refinance into a conventional loan.
Borrowers with credit scores below 620 don't qualify for conventional mortgages, so FHA is the most likely option for them. Borrowers with credit scores of 720 or higher will usually find that conventional loans cost less per month. And borrowers with credit scores lower than 720 will usually find that FHA loans cost less per month.
A mortgage loan officer can walk you through the options.
One other thing: If you are serving in the military or are a veteran, a loan backed by the VA may be the way to go. VA loans usually require no down payment. And if you live in a suburban or rural area, a USDA loan could be a smart option, too.
FHA Loans 101
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