FHA Home Loans vs. Conventional Mortgages

For most mortgage shoppers, deciding which home loan is the best can be overwhelming. Often times, the decision comes down to FHA mortgages versus conventional mortgages. Though there are distinct advantages of choosing FHA financing, sometimes conventional financing may be the better option.

The main advantage to FHA home loans is that the credit qualifying criteria for a borrower are not as strict as conventional financing. FHA will allow the borrower who has had a few "credit problems" or those without a credit history to buy a home. FHA will require a reasonable explanation of these derogatories, but will approach a person's credit history with common sense credit underwriting. Most notably, borrowers with extenuating circumstances surrounding bankruptcy that was discharged 2 years ago can work around the credit hurdles they created in their past. Conventional financing, on the other hand, relies heavily upon credit scoring. Credit scoring is a rating given by a credit bureau (such as Experian, Trans-Union, or Equifax) that ranks you upon your credit profile. For each inquiry, credit derogatory, or public record that shows up in your credit report, your score is lowered (even if such items are in error). If your score is below the minimum standard, you will not qualify--end of story.

Furthermore, HUD has created a list of allowable and non-allowable closings costs that can be assessed to the borrower. This can save a home buyer hundreds of dollars when buying a home. On the other hand, conventional financing has not set mandate and most buyers are charged the fees.  

FHA is one of the few home mortgage programs that allow a borrower to have their down payment gifted from a family member, a governmental agency, or non-profit organization. This allows home buyers without the necessary money to buy a home today. Conventional financing will not allow gifted funds.

Even though FHA charges an annual renewal mortgage insurance premium of 0.5% of the loan amount, this fee is generally half that charged by low down payment conventional mortgages (which range from 0.78% up to 1.01% per year). For a $100,000 mortgage, FHA would charge approximately $41.67 per month and a typical low down conventional mortgage with a renewal premium of 0.78% would charge $65.00 per month. That's a $280 savings per year. On the other hand, if the borrower is putting 10% or more down on the property, the annual renewal premium are about the same if not lower than that set by FHA.

However, conventional financing does not require an upfront mortgage insurance premium when a borrower closes on the loan. With FHA financing, that fee for a 30 year loan is 2.25% of the loan amount (or 2.0% for a 15 year mortgage) that the borrower can wrap into the mortgage. On a $100,000 for 30 years at 8%, that's an additional $16.51 that the borrower must pay each month. That's almost an additional $200 the borrower must pay each year (fortunately the interest a borrower pays on his or her mortgage on a primary residence is tax deductible).  

Also, the loan limits set for FHA loans are typically less than the loan limits for conventional financing in most parts of the country. If a borrower is looking for a mortgage that exceeds the FHA loan limits for the area, the borrower would have to put additional money down on the property or finance under a conventional mortgage.  

Deciding which course of action can be a difficult decision. As we have shown above, there are many factors that you must weigh when deciding which type of loan--FHA loans or conventional mortgages--better serve your needs. Sit down with your loan officer or financial advisor and look at not only the short term impact of the decision but also at the long term costs of each program.