One of the hardest choices during the home buying process is deciding between an FHA loan or a conventional loan. First time home buyers especially go back and forth choosing between the two. The two programs have the biggest rivalry in the mortgage industry! Determining your loan program depends on your situation and what fits best for your family and your wallet. Let’s break down each program’s qualification factors and the pros and cons of both to help you decide which one is right for you.
FHA Loan
The Federal Housing Administration, or FHA loans are government backed. This means if you can’t make your monthly mortgage payments due to a financial crisis (job loss, loss of a family member etc.), the FHA program offers up to 12 months of mortgage payment assistance. It’s also the most popular program for first time home buyers.
Down Payment
Single family home = 3.5% down
Duplex, triplex, multi unit = 3.5% down
Occupancy
-Owner occupied only
-First time home buyer
-Second home
Credit
-580+ FICO
*In states with community property laws, your spouse’s credit is required to apply and qualify for an FHA loan.*
Income
W2: 2 years of same employer tax documents
Self employed: 5 years of self employed tax documents
DTI
45 / 55 maximum DTI
For example:
-Gross monthly income = $10,000
-Max monthly debt = $5,500
-Max monthly mortgage payment = $4,500
Private Mortgage Insurance
The FHA program requires private mortgage insurance (PMI).
Interest Rate
The FHA loan typically offers lower interest rates than conventional loans.
Pros
- Government backed
- Popular for first time home buyers
- Low down payment options
- Lower minimum credit score
- Lower interest rates
- Higher maximum DTI
Cons
- Owner occupied only
- Longer income history
- Private mortgage insurance
Conventional Loan
Conventional loans are not backed by the government. This program is government sponsored under Fannie Mae and Freddie Mac.
Down Payment
First time home buyer = 3%-5% down
Second home= 5% down
Duplex, triplex, multi unit= 15%-25% down
Occupancy
-Owner occupied
-First time home buyer
-Second home
-Investment home
Credit
620+ FICO with 10%-20% down payment
680+ FICO with 3%-5% down payment
*Spouse credit is NOT required in order to apply or qualify for a conventional loan.*
Income
W2: 2 years of same employer tax documents
Self employed: 1 year of self employed tax documents
DTI
45 / 50 maximum DTI
For example:
-Gross monthly income = $10,000
-Max monthly debt = $5,000
-Max monthly mortgage payment = $4,500
* If you have less than 10 payments left towards paying off a debt (except a car lease) you can omit that debt from your DTI to help qualify for more home.*
Private Mortgage Insurance
Here’s a few ways you can remove PMI from your monthly mortgage payment:
-Pay it off upfront
-Pay more monthly until you gain 10% equity for it to fall off
-Wait for it to automatically fall off after 11 years
Interest Rate
The conventional loan typically offers higher interest rates than FHA loans depending on your credit, DTI and down payment.
Pros
- Flexible occupancy
- Shorter income history
- Debt omission options
- Options for removing PMI
Cons
- Higher down payment
- Higher minimum credit score
- Lower maximum DTI
- Higher interest rates
Bottom Line
Depending on your situation, the FHA loan might be the best option if you have fair credit and low down payment. Or, conventional might be the best option if you have good credit and shorter income history. The best way to find out which program is right for you is to reach out to your lender so they can review both options and explain which one fits your ideal scenario.
