For most mortgage borrowers, there are three major loan types: conventional, FHA and VA. Each loan type comes with a different set of qualifications, benefits and drawbacks.
A conventional loan is a mortgage that is not backed or insured by the government, including all Federal Housing Administration, Department of Veterans Affairs, or Department of Agriculture loan programs. Conventional loans typically have fixed interest rates and terms.
An FHA loan is a loan that’s insured by the Federal Housing Administration. The FHA does not lend money, it just backs qualified lenders in case of mortgage default. There are certain criteria both borrowers and lenders must meet to get FHA approval.
Like with FHA loans, VA loans are insured by the U.S. Department of Veteran Affairs, or VA. The VA does not lend money; it insures qualified lenders. If a borrower defaults on their home loan, then the lender is protected by the VA. The lenders and borrowers must both meet qualifications to be VA eligible.
To get an idea of which loan might be right for you, start by getting the basic facts.
Here is how they compare.
Conventional loans are, by far, the most popular type of mortgage for all homebuyers. The U.S. Census Bureau reported that conventional loans made up 73.8 percent of new home sales in the first quarter of 2018, the highest share in a decade. It’s been above 71 percent over the last seven quarters.
FHA loans came in a distant second, making up just under 12 percent of all loans in Q1, followed by VA loans with just 8.7 percent and, in last place, was cash claiming 5.2 percent of the share of new home sales.
Conventional mortgages are ideal for borrowers with good or excellent credit. Although, depending on the financial institution and the borrower’s circumstances, people with credit problems might qualify for a conventional loan. Usually, credit unions and independent banks, which often have more personalized relationships with their customers, are more likely to bend Fannie Mae rules, which most big banks follow.
PRO: Conventional mortgages generally pose fewer hurdles than Federal Housing Administration or Veterans Affairs mortgages, which may take longer to process.
CON: You’ll need excellent credit to qualify for the best interest rates.
Federal Housing Administration mortgages have flexible lending standards that you can benefit from:
- People whose house payments will be a big chunk of take-home pay.
- Borrowers with low credit scores.
- Homebuyers with small down payments and refinancers with little equity.
The FHA allows borrowers to spend up to 56 percent or 57 percent of their income on monthly debt obligations, such as mortgage, credit cards, student loans and car loans. In contrast, conventional mortgage guidelines tend to cap debt-to-income ratios at around 43 percent.
For many FHA borrowers, the minimum down payment is 3.5 percent. Borrowers can qualify for FHA loans with credit scores of 580 and even lower.
Each FHA loan has two mortgage insurance premiums:
- An upfront premium of 1.75 percent of the loan amount, paid at closing.
- An annual premium that varies. Most FHA homebuyers get 30-year mortgages with down payments of less than 5 percent. Their premium is 0.8 percent of the loan amount per year, or $66.67 a month for a $100,000 loan.
PRO: FHA loans are often the only option for borrowers with high debt-to-income ratios and low credit scores.
CON: To get rid of FHA premiums, you must refinance the loan.
No down payment is required from borrowers buying primary residences. The VA charges an upfront VA funding fee, which can be rolled into the loan or paid by the seller. The funding fee varies from 1.25 percent to 3.3 percent of the loan amount.
The VA allows sellers to pay closing costs but doesn’t require them to. So, the buyer might need money for closing costs. Borrowers may need money for the earnest-money deposit.
PRO: Veterans do not have to be first-time buyers and may reuse their benefit.
CON: The VA does not guarantee the full amount of the loan, which means borrowers might be subject to additional requirements from the bank. The amount the VA guarantees, which varies by county, might affect how much the bank is willing to lend.