Which is better, FHA or Conventional Mortgage Loans?

© 2009, Brandon Cornett. All rights reserved.

Question: “I’ve been hearing a lot about FHA home loans lately, and how they offer certain advantages over conventional mortgage loans. What’s the difference between them? And which is better, FHA or a conventional mortgage loan?”

I can’t answer the “better” part, because it’s a relative term. It also depends on the type of real estate market you’re in. In a seller’s market, for example, there are certain disadvantages to using an FHA loan. So instead of picking a winner between these two financing options, let’s talk about the primary differences between them. Then you can decide which option is better, based on your particular needs.

Let’s start with a basic definition, for the benefit of all readers:

• FHA Home Loan — Any mortgage loan that is insured by the Federal Housing Administration, a government agency under the Department of Housing and Urban Development (HUD). The loan itself is made by a regular lender, such as Citi or Wells Fargo. The FHA just insures the loan against losses, such as when a homeowner defaults.
• Conventional Loan — One that is not insured by any government agency.

Which is the Better Option for You?

So which is better, the FHA option or the conventional loan option? This depends on several factors. And once again, it comes down to the difference between this financing methods:

How much of a down payment do you have? If you use a conventional mortgage that is not backed by the government, you’ll probably have to put at least 10% down — and maybe up to 20%. If you use an FHA loan, on the other hand, you could put as little as 3.5% down on the mortgage. So for a home buyer who lacks the up-front cash, the FHA-insured mortgage might be the better option.

And how about your credit score? If you have less-than-perfect credit, or other problems that may prevent you from getting a loan approval, the FHA mortgage might be the better option. Generally speaking, it’s easier to get approved for a loan that’s insured by Federal Housing Administration. This insurance protects the lender from borrower default, so they are less strict with their qualification / underwriting criteria. If you want to know which is the better financing option, FHA or conventional loans, you have to consider your own credit score.

You also need to consider your real estate market. Are you in a seller’s or buyer’s market? In a seller’s market, where many buyers are competing for a limited number of homes, a government-insured loan could actually be a disadvantage for you. That’s because it requires extra and more stringent inspections. As a result, a seller who is choosing between several offers might dismiss the person who is using an FHA loan. Of course, they won’t come out and disclose this — but it still happens. This is something to consider when determining which is better, the conventional mortgage or the FHA loan.