Conventional loans are generally better for borrowers with good credit (620+) and a 5%+ down payment due to cancellable mortgage insurance, while FHA loans are better for lower credit scores (500–620) or smaller down payments (3.5%). Conventional loans offer more flexibility, whereas FHA loans provide more lenient qualifying criteria.
FHA loans typically come with more competitive interest rates than conventional loans. The reason is because FHA loans are backed by the government, so the lender faces lower risk. It's important to note that FHA loans also require mortgage insurance no matter how large of a down payment you make.
Conventional loans can require less paperwork and can be obtained more quickly than government-insured loans. Mortgage lenders can approve conventional loans without the typical delays incurred with FHA or government-backed loans.
It all comes down to risk. An FHA financed offer is riskier to the Seller than a Conventional loan or an ARM. Try writing FHA with an Appraisal Gap or the Buyer will take care of Inspection items up to (fill in the blank) amount. Those things help mitigate that risk in the FHA appraisal.
The main cons of FHA loans are mandatory Mortgage Insurance Premiums (MIP) – both upfront and annual, which can last for the life of the loan or 11 years depending on down payment. Other downsides include strict property standards, lower loan limits in high-cost areas, higher long-term costs (especially with good credit), and limitations to primary residences only, which can make them less appealing to sellers and buyers with excellent credit seeking better conventional loan terms.
FHA loans are designed to help make homeownership more affordable for Americans with moderate incomes or lower credit scores. But like any mortgage, FHA loans require the borrower (or seller) to pay closing costs, even though they're backed by the U.S. Federal Housing Administration (FHA).
The FHA 85% rule refers to a past guideline for cash-out refinances limiting the loan to 85% Loan-to-Value (LTV) and a specific rule for identity-of-interest transactions (like buying from family) where borrowers couldn't finance more than 85% of the home's value unless exceptions applied, such as renting from the family member for at least six months prior. While the general cash-out LTV is now 80%, the 85% rule still applies to certain related-party sales, requiring a 15% down payment unless an exception is met, notes FHA.com.
The 3-7-3 Rule in mortgages isn't a loan type but a federal timeline from the TILA-RESPA Integrated Disclosure (TRID) rule, ensuring borrower protection by mandating disclosures within 3 business days of application, a 7-business-day wait between the initial Loan Estimate and closing, and another 3-day wait if significant changes (like APR) occur, giving borrowers time to review costs before committing to a loan.
Conventional Loan: Cons
FHA estimated closing costs are generally about 2–6% of the loan amount (not the purchase price). This is a little higher compared to the 2–5% for conventional loans. The expanded range is primarily due to MIP. While it might not sound like a huge increase, even a 1% difference can mean significantly higher costs.
FHA loan disqualifications often stem from poor credit (below 500), high debt-to-income (DTI) ratios (often above 43%), unstable employment, insufficient funds for down payment/closing costs, or issues with the property itself, like hazards or severe disrepair, plus owing back federal debts or having delinquent student loans. Clearing federal debt, establishing stable income, and ensuring the home meets safety standards are key to overcoming these hurdles, notes FHA.com and The Home Loan Expert.
Closed-end debts do not have to be included if they will be paid off within 10 months from the date of closing and the cumulative payments of all such debts are less than or equal to 5 percent of the Borrower's gross monthly income. The Borrower may not pay down the balance in order to meet the 10-month requirement.
Uninsurable property is a home that is not eligible for insurance through the Federal Housing Administration (FHA) because it needs extensive repairs. An uninsurable property is typically ineligible for a mortgage through the FHA.
Broadly speaking, it may be more difficult to qualify for a conventional loan than a government-backed mortgage. You may need to meet higher credit score or down payment requirements, for example.
For a $400,000 home, expect closing costs to generally fall between $8,000 to $24,000 (2% to 6% of the home price), though it can vary by location and lender, with some estimates placing typical costs around $8,000 to $12,000 (2% to 3%) for fees, plus prepaid items like taxes and insurance, leading to a total cash needed closer to $12,000-$15,000. Key costs include loan origination, appraisal, title, property taxes, and insurance, with higher percentages often seen on lower-priced homes due to fixed-cost fees.
FHA loan closing costs typically total 2 percent to 6 percent of a home's purchase price and are charged in addition to the down payment. FHA closing costs include an upfront mortgage insurance premium (MIP), lender and third-party fees and prepaid expenses.