Reader question: “I keep hearing about conventional mortgage loans for home buyers, and how they are harder to get than an FHA loan (for some reason). What are the main differences between FHA and conventional home loans? And why would one be harder to obtain than the other, if in fact that’s true?”
Here’s the primary difference between these two types of home loans:
- A conventional mortgage product is originated in the private sector, and is not insured by the government.
- An FHA loan is also originated in the private sector, but it gets insured by the government through the Federal Housing Administration. This insurance protects the lender, not the borrower.
A conventional mortgage loan can also be insured. But in this case, the coverage comes from a third-party insurance company within the private sector. It does not come from the government. That’s why it’s called private mortgage insurance, or PMI.
That’s the main difference between FHA and conventional home loans. Here is some additional, in-depth information you might find helpful.
In-Depth: Difference Between FHA and Conventional Loans
Regardless of whether you apply for a conventional or an FHA-insured loan, you will apply through a mortgage lender that operates in the private sector. That’s where the money comes from. So you will have to meet the lender’s minimum guidelines for approval, and you’ll have to clear their underwriting process.
The difference with the FHA program (and it’s a big difference) is that you have to meet two sets of qualification criteria. You have to meet the lender’s criteria, as well as the government’s. The program is managed by the Department of Housing and Urban Development, or HUD, which is part of the federal government.
You might think it would be harder to get an FHA loan (compared to conventional financing) because of this “two-tiered” qualification system. But the opposite is true. Generally speaking, it’s easier for borrowers to qualify for an FHA-insured home loan.
By insuring the mortgage, the government is basically guaranteeing that the lender will repaid — even if the borrower defaults on the loan. That’s why lenders are generally more relaxed with their guidelines, when making government-insured loans. This is another major difference between conventional and FHA loans.
Since the lender has a higher degree of protection against default, they’re usually willing to take on a higher degree of risk (such as a borrower with a few credit dings in the past). In short, they might not be as strict with certain qualification criteria.
So, as you can see, the government does not actually lend money directly to consumers. At least, not through the FHA program. Instead, they insure certain loans originated by lenders operating in the private sector. This accounts for the official name of the program — it’s officially called the “HUD 203(b) Mortgage Insurance” program, because the government insures the loan. That’s the main difference between FHA and conventional financing.
Down Payments: Another Key Distinction
FHA loans also require less of a down payment, when compared to conventional mortgages. Borrowers can put down as little as 3.5% of the purchase price or the appraised value of the home (whichever is less). This is what makes the program so popular among first-time buyers with limited cash.
In 2017, some lenders are offering conventional mortgage loans with down payments as low as 3%. But for the most part, lenders require at least 5% down for conventional financing. So FHA is usually the best option for home buyers who are trying to minimize their upfront, out-of-pocket expense.
Just keep in mind there are no perfect mortgage products. They all have certain pros and cons associated with them. So the best thing you can do, as a home buyer, is to learn about these pros and cons. Once you do that, the best financing option will emerge.
Now that you understand the primary differences between FHA and conventional mortgage loans, you can research the pros and cons associated with each option.