If you’re in the market for a mortgage, you may have come across the terms “FHA loan” and “conforming loan” and wondered what the difference is. In this article, we’ll explain the key differences between FHA loans and conforming home loans and help you determine which type of loan may be the best fit for your situation.
What is an FHA loan?
An FHA loan is a mortgage loan that is insured by the Federal Housing Administration (FHA). This type of loan is a good option for homebuyers with less-than-perfect credit or limited cash for a down payment. On the other hand, a conforming loan is a mortgage loan that conforms to the guidelines set by government-sponsored enterprises Fannie Mae and Freddie Mac. These loans typically offer better interest rates and terms than non-conforming loans.
FHA Loan and Conventional Home Loan Credit Score Requirements
One key difference between FHA loans and conforming loans is the minimum credit score required to qualify. FHA loans have a lower minimum credit score requirement than conforming loans, making them a good option for first-time homebuyers or those with less-than-perfect credit. Conforming loans, on the other hand, typically require a higher credit score to qualify.
FHA loans will typically allow home buyers to qualify with a credit score as low as 580. Select programs may even allow credit scores as low as 500.
Conventional loans require a minimum credit score of 620, and are often less affordable than FHA loans unless the borrower has a credit score of 680 or higher.
Conventional and FHA Loan Down Payment Requirements
Another difference between FHA loans and conforming loans is the down payment requirement. FHA loans allow for a down payment as low as 3.5%, while conforming loans typically require a down payment of at least 5%. This can make FHA loans an attractive option for first-time homebuyers or those with limited cash for a down payment.
Note: there are some first time home buyer programs that allow home buyers to put down as little as 3% when buying a home with a conventional loan. These first time home buyer programs are subject to additional income and property eligibility requirements, making FHA loans a more common loan product for first time home buyers.
Debt to Income Ratio Requirements for Conventional and FHA Loans
FHA loans also have more flexible debt-to-income (DTI) ratios than conforming loans. DTI ratio is a measure of how much of your monthly income is spent on debt payments, including your mortgage, credit cards, student loans, and other debts. FHA loans typically allow for higher DTI ratios than conforming loans, which can be a benefit for borrowers with high levels of debt.
FHA loans will typically allow home buyers to qualify with a DTI as high as 55%, whereas conventional loans tend to require a DTI under 43%.
You can calculate your debt to income ratio yourself by dividing your monthly recurring debt obligations (mortgage, car loan payments, credit card payments, personal loans, and other installment debt) by your gross monthly income.
Note that non-debt monthly obligations such as utilities, phone bills, and similar expenses are not factored into your DTI.
FHA and Conventional Mortgage Interest Rates
FHA loans and conforming loans are typically similar. However, because FHA loans are insured by the government, they may offer more favorable interest rates for borrowers with lower credit scores or who are making a smaller down payment.
One important thing to note about FHA loans is that they are only available for single-family homes and certain types of multi-family properties. Conforming loans, on the other hand, can be used to finance a wider range of property types, including single-family homes, multi-family homes, and condominiums.
Summary
FHA loans and conforming loans are two different types of mortgages that have their own unique requirements and benefits. FHA loans are a good option for homebuyers with less-than-perfect credit or limited cash for a down payment, while conforming loans may be a better choice for those with higher credit scores or who want to finance a more expensive property. It’s important to compare the different loan options available to you and consult with a mortgage lender to determine which type of loan is the best fit for your situation.