Is a conventional mortgage or FHA loan better?

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Conventional Mortgage or FHA Loan

Purchasing a home is a large investment. In addition to paying your principal balance—the money you borrow—along with interest, you may have to pay for mortgage insurance. Mortgage insurance protects the lender (not the homebuyer) if the borrower defaults or doesn’t pay the loan.

Mortgage insurance at a glance

If you opt for a conventional mortgage and your down payment is less than 20% of the home’s value, your lender will require private mortgage insurance. This price will vary, depending on your credit score and down payment amount, and will range between $30–70 per month for every $100,000 borrowed, according to Zillow. Once your loan-to-value ratio (LTV)—the loan amount divided by the value of the home—hits 80%, meaning you own 20% of your home, you can cancel private mortgage insurance in most cases.

If you take out a FHA loan, you’re essentially getting a mortgage insured by the government or Federal Housing Administration. The borrower also pays for this type of mortgage insurance to protect the lender. The FHA charges a 1.75% premium up front in addition to an annual premium on home loans insured by the government, as reported by the LA Times. This is a percentage of the total purchase price of your home. Both the upfront and annual premiums can be broken out into monthly payments as a part of your total house payment.

Another major difference that will affect your costs is the life of your mortgage insurance obligation. With an FHA loan, the borrower will pay mortgage insurance premiums for the life of the loans, versus until the LTV ratio hits 80% with private mortgage insurance.

There is some good news, however. In January, the White House announced a 0.5% reduction in annual mortgage insurance premiums for FHA loans, taking it from 1.35% to 0.85%. Over the lifetime of a loan that can add up to significant savings.

It pays to shop around for different FHA-approved lenders (the FHA is not itself a lender) as they may offer varied interest rates and costs for the loan, according to Bankrate.com.

When does it pay to do a conventional mortgages versus FHA loan?

So why would you take one loan over the other?

FHA loan

In many cases, the FHA makes the dream of homeownership a reality for buyers who may not qualify for a traditional mortgage. According to HUD.gov, FHA loans often require lower down payments—even as low as 3.5%. They are also more forgiving when it comes to qualifying for a home loan when looking at your credit score and your debt-to-income ratio—your total recurring monthly debt divided by monthly income (before deductions).

According to the LA Times, student loan debt is a major hindrance for the up-and-coming homeowner generation, and FHA loans are helping. Borrowers typically must have a debt-to-income ratio lower than 45% to qualify for a conventional mortgage. FHA loans will go above 50%, depending on the situation.

Conventional mortgage

On the flip side, conventional mortgages can help homeowners build equity—the amount of the home you own—faster, according to the LA Times, as the mortgage insurance payments eventually drop off. Conventional mortgages require a higher FICO credit score—the most common type of credit score used to determine loan eligibility. Credit scores are also used to determine the cost of private mortgage insurance in comparison to the set costs associated with an FHA loan, according to Zillow. So better scores can lower monthly payments as well. Conventional mortgages oftentimes require or make more financial sense when more money goes toward a down payment.

Consider your own circumstances, such as income, debt, credit score, money saved for a down payment, and the amount of monthly payments you can afford when deciding which type of mortgage is best for you.

If you’d like to talk about the mortgage process with a mortgage banker, please feel free to contact us. No pressure—just friendly words of wisdom you can use to make the best decision possible. 

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