FHA vs. Conventional Loans

  Although there are similarities between an FHA mortgage and

  a conventional loan, the differences prevail.  Aside from the

  fundamentals such as that both finance home purchases, there

  is really only one important similarity, and that is the interest

  rate.  Generally, if there is any difference at all between an

  FHA rate and a conventional rate, it is a small fraction of a

  percent. 

  Differences rule between FHA and conventional loans, as the

  list of important distinctions includes credit qualification,

  income restrictions, mortgage insurance fee, down payment,

  and debt ratios, and subsequent to the latter two, purchase

  amount. 

  Credit and Income: You can qualify for an FHA loan with a

  FICO score well under 620 (how low will be determined by

  the underwriter or automated underwriter), only two full years

  out of the discharge of a bankruptcy, and with collection

  accounts totaling less than $1000 and not more than $250

  each.  Additionally, if the borrower has not yet established

  credit, he or she is allowed to use “alternative credit,” or proof

  of timely payment from utility bills, auto or medical insurance

  premiums, child care, school tuition, etc.  FHA allows for

  borrowers with less than perfect credit to receive the same

  interest rate as a borrower with unblemished credit.

  Mortgage Insurance: Rather than a conventional mortgage

  insurance fee in the vicinity of .75% - 1.25% annually, with

  an FHA loan you pay an annual mortgage insurance premium

  of .5% of the loan amount divided by 12 months.  This

  amount is deducted from the Up Front Mortgage Insurance

  Premium (UFMIP) and if, for any reason, you refinance out of

  the FHA loan, the remainder of your UFMIP is refunded to

  you.   

  Down Payment and Debt Ratios: While conventional loans

  require a down payment of 5% or higher, FHA requires a

  down payment of 3%. Unlike conventional, this money can

  be a gift, and this gift can be received from family or from a

  charitable organization.  Additional reserves are not required.

  Qualifying debt ratios are higher than conventional loans,

  with 29% of income allowed for housing expense, and 41%

  for total monthly expense.   With lower down payment

  requirements and higher debt ratios, you can qualify for more

  of a home with the same savings and/or income.

  FHA Restrictions: FHA loans have an income restriction as

  well as loan amount limits.  These are calculated annually

  according to your county.   See the HUD site for more

  information.

  At bottom, these strengths allow low-income families to

  qualify for and afford a home, and moderate-income families

  to purchase more of a home than at conventional

  qualifications.  For those looking to buy a home within the

  loan and income limits for their county an FHA loan may be a

  smart move.