A good credit score is a must when thinking about taking a loan. It allows a lender to recognize the
risk involved in lending money an individual. There are various types of loans that can be availed
according to the credit score one has.
FHA vs Conventional Loans
The main difference between FHA and Conventional Loans is that FHA is a government-backed loan which you can take even if you do not have a good credit score. On the other hand, conventional loans are backed by private lenders. Conventional Loans require a borrower to have a good credit score.
FHA loans are ensured by the Federal Housing Administration. This kind of loan is backed by a government agency and has very few restrictive qualifications for the borrower. So, a person with a lesser credit score can borrow money easily using this. However, the down payment for FHA loans can be quite high depending on your credit score.
Conventional Loans are loans for those people who have a good credit score. They are backed by private lenders and no government agency is involved in the process. However, to qualify for such a loan there are a lot of restrictions. Moreover, a low DTI ratio is required along with a down payment.
Comparison Table Between FHA and Conventional Loans
| Parameters of Comparison | FHA | Conventional Loans |
| Credit score | An individual can borrow money even if their credit score is less. | An individual can only borrow money if they have a high credit score. |
| Insurance | FHA loans are insured by the government. | Conventional loans are insured by private lenders. |
| Requirements | FHA loans require a borrower to have a credit score of 580. | Convention loans require a borrower to have a credit score of 620 or higher. |
| Down Payment | A borrower can get this loan even if the down payment is as low as 3.5%. | A borrower has to pay down 20% or use the option of private mortgage. |
| Competition | FHA loans are competitive because they are backed by the government and thus not very risky. | Conventional loans are less competitive as they are backed by private loan lenders and may be risky. |
| Qualification | FHA loans have fewer restrictive qualifications. | Conventional loans have more restrictive qualifications. |
What is FHA?
FHA is a home loan that the Federal Housing Administration insures. This type of loan is backed by the government. It has few restrictive qualifications, allowing people to borrow money even with a low credit score. A person can borrow money with a credit score of 580 or higher.
Money can be also be borrowed by an FHA loan with a credit score of 500. However, this comes with various implications. The higher your credit score a person has, the lower the down payment. For example, when you have a credit score of 580, the down payment is 3.5%. However, when you have a lesser score, the down payment is 10%.
Every loan has a limit according to the home you want to purchase. The limit depends on which location you choose to set up your home. Moreover, these limits are changed every year. It may depend on whether the place is rural, middle-class or upper class.
It is necessary to pay a mortgage insurance premium while taking an FHA loan. This amount is either paid for as long as you take the loan, or for 11 years of you pay 10% down payment. The amount of money to be paid depends on the total mortgage, length of mortgage, etc.
What is Conventional Loans?
Conventional loans are home loans that are insured by private lenders. To avail such type of a loan, the credit score of a person should be at least 620. Even though it is difficult to get a conventional loan, the repayment terms are very flexible. It is the decision of the lender whether or not a borrower is eligible.
The down payment for a conventional loan is 20%. However, when an individual is unable to pay a 20% down payment, they have an option to pay private mortgage insurance. The interest rate depends an individuals credit score as well as their loan-to value ratio.
The repayment terms of conventional loans are quite flexible. However, if a small down payment is made, the risk for the lender increases. Lenders can put more trust in borrowers when they have a high credit score or have made a larger down payment.
The types of conventional loans include conforming conventional loans, Jumbo conventional loans, Portfolio Loans, Subprime conventional loans, Amortized Conventional Loans and Adjustable conventional loans. Even though these loans have low interest rates, higher loan limits and flexibility, they have their cons as well. These loans require a high credit score and have strict qualifying guidelines.
Main Differences Between FHA and Conventional Loans
- A person can qualify for an FHA loan even if their credit score is lesser. Conventional loans are only granted for people with higher credit scores.
- FHA loans are ensured by the government while conventional loans are ensured by private lenders.
- FHA loans require less down payment while conventional loans require a high down payment.
- FHA loans are competitive while conventional loans are not.
- FHA loans are not as flexible as the latter and have higher interest rates.
Conclusion
Buying a new home is not an easy task, which is why loans are of major help. FHA and Conventional loans are both good options for people who are looking for easy borrowing. While FHA loans have lenient restrictions, conventional loans have a lot of restrictive qualifications.
Moreover, FHA loans are given even to those who have a low credit score. On the other hand, conventional loans require a persons credit score to be at least more than 680. So, if you don’t have enough money to make a down payment for a conventional loan, FHA is the right choice to make.
References
- https://www.jstor.org/stable/1060046
- https://onlinelibrary.wiley.com/doi/abs/10.1111/1540-6229.00803