Home buyers tend to have a lot of questions about the FHA loan program, and many of those questions relate to mortgage rates. One of the most common questions we receive from borrowers is:
Do FHA loans offer lower rates than conventional mortgages? Which is better from a cost standpoint, FHA or conventional?
This question is actually more complex than it seems at first glance. So we will offer a short answer for those in a hurry, along with a more in-depth explanation for those seeking a deeper level of understanding.
Conventional Versus FHA Loans: Definitions and Differences
We should start with the key differences between conventional and FHA loans. It’s important to understand how these two mortgage products are different, because it relates to the mortgage rate you receive from a lender.
An FHA loan is insured by the federal government through the Federal Housing Administration. This agency falls under the Department of Housing and Urban Development, or HUD. This insurance protects the lender, not the borrower. Lenders who offer FHA loans can file insurance claims if the borrower defaults on the loan down the road (i.e., stops making payments).
A conventional home loan does not receive any kind of government guarantee or insurance. This sets it apart from both the FHA and VA programs, which do have government backing. Conventional mortgage products are originated within the private sector. In some cases, a conventional mortgage loan might require insurance similar to the FHA program. But the insurance policy is provided by a company in the private sector – not by the government. That is the key distinction between conventional and FHA home loans.
Which One Offers Lower Rates?
Which kind of mortgage loan offers lower interest rates, FHA or conventional? The answer is that it depends.
Your mortgage rate is primarily determined by your credit score, the size of the loan, the amount of your down payment, and the rate structure (fixed versus adjustable). Those are the primary factors that will determine the mortgage rate you receive from a lender. Choosing an FHA or conventional loan has a lesser impact on the rate you receive.
With that being said, some surveys have shown that FHA borrowers receive lower rates than conventional mortgage borrowers, on average. Perhaps this is due to the government provided insurance that we discussed earlier. Lenders might be willing to offer better mortgage rates for an FHA loan, because they know they are insured up to a certain amount in the event of borrower default.
But this is just one factor of several that can affect the rate you receive from a mortgage lender. Here are some other factors:
- Discount points: Some borrowers choose to “buy down” their mortgage rate by paying discount points at closing. In this context, one point equals 1% of the base loan amount (i.e., $1,000 for every $100,000). This is a form of prepaid interest. You are essentially paying more money up front in exchange for a lower rate, which reduces your monthly payments. Depending on how long you keep the home and the mortgage loan, this could end up saving you a significant amount of money over time.
- Credit score: We talked about the importance of credit scores earlier. These three-digit numbers serve as an indicator of risk. Mortgage lenders use risk-based pricing when assigning rates to home loans. This is true for both conventional and FHA. In short, a borrower who is perceived to be a higher risk to the lender will generally be charged more interest. A “less risky” borrower might qualify for a lower mortgage rate. So a higher credit score can help you qualify for a better rate, on both an FHA and a conventional home loan.
- Fixed versus adjustable: The structure of your home loan can also influence the rate you receive. Both FHA and conventional mortgage loans are available with either a fixed or adjustable rate structure. Generally speaking, fixed home loans come with higher mortgage rates. In contrast, borrowers who choose adjustable-rate mortgage (ARM) loans typically qualify for lower interest rates during the first phase of the mortgage. The downside to using an ARM loan is that the rate can change after the initial stage during which it remains fixed.
Disclaimer: This article answers the question, do FHA loans offer lower rates than conventional? Every lending scenario is different because every borrowers different. So your situation might differ from the scenarios mentioned above. The best way to find out what kind of mortgage rate you can get is to request a quote from a lender. We encourage borrowers to get multiple quotes so that they can comparison shop for the best deal.