Is FHA Or Conventional Better For First-Time Homebuyers?
First-time homebuyers often face challenges on the road to homeownership. Lower credit scores, below-average income, and high home prices can make qualifying for a home tough.
So which loan is better to address common first-time buyer struggles, FHA or conventional?
The quick answer is FHA. This loan is easier to qualify for. That’s why first-time buyers account for more than half of all FHA purchase mortgages.
But FHA isn’t better for every first-time buyer. In fact, in 2018 (the most recent data available), 44% of first-time buyers used a conventional loan while only 27% used FHA.
Conventional is gaining steam, partly because of recent changes making it easier for first-time buyers to qualify. Let’s find out which loan might be right for you.
Summary: Is FHA Or Conventional Better For First-Time Buyers?
Here are common challenges for first-time buyers and which loan type better addresses it.
Lower credit scores: FHA is better.
Higher debts/lower income: FHA is better.
Rejected offers: Conventional is better.
High mortgage rates: Conventional recently lowered rates for moderate-income first-time buyers.
High mortgage insurance costs: Conventional could be better for those with 5% down and 740+ credit, but FHA is usually cheaper.
Credit Scores: FHA Is Better
The hands-down winner here is FHA.
FHA loans allow credit scores down to 580 and are much more forgiving when it comes to credit issues like bankruptcies, late payments, and collections. The minimum conventional credit score is 620.
You still have to show reasonable credit responsibility over the past year or so for FHA. But a few late payments and even major derogatory items that are a few years old may be acceptable depending on the rest of your profile.
Higher Debts/Lower Income: FHA Is Better
Debt-to-income ratio, or DTI is the comparison between monthly debt payments and gross income.
For example, if you have $5,000 per month in gross income, and $2,500 per month in debt and housing payments, your DTI is 50%.
FHA loans often allow DTIs upwards of 56%. This is a major boost when you have a moderate income or high debts. Conventional loans max out at about a 43-45% DTI.
It’s very tough to have a low DTI in today’s market. Home prices are high and so are interest rates. This combination could make your future monthly payment high, driving up your DTI to levels only FHA can accept.
Rejected Offers: Conventional Is Better
One big challenge for first-time buyers is getting their offer accepted by the home seller.
Most buyers are not able to offer all cash or even a 20% down payment – elements that sellers like to see.
However, to make an offer slightly stronger, use conventional financing.
Some home sellers won’t accept an FHA offer. They think these are weaker buyers that may be denied mid-process. While this isn’t often the case, the perception is enough to get your offer rejected.
Additionally, FHA comes with stricter property requirements, potentially forcing the seller to make repairs.
In competitive seller’s markets, a conventional loan offer could make the difference between getting the home or not.
High Mortgage Rates: Conventional Has Made Improvements
Fannie Mae and Freddie Mac, the two agencies that create rules for most conventional loans, recently rolled out a huge discount.
First-time buyers who make 100% or less of their area’s median income now get their risk-based rate increases waived. If you live in a high-cost area, your income can be 120% of your area’s median and still receive the discount.
For example, someone with a 660 credit score putting 3% down on a conventional loan would pay 1.25% of the loan amount in extra fees. Most buyers choose to increase their rate by about 0.25-0.75% in lieu of the fee.
If that buyer has moderate income, though, they get that rate increase waived, saving between $60-$190 per month on a $300,000 loan.
Because of these risk-based fees, FHA used to be the loan of choice for buyers without perfect credit and a large down payment. Now, conventional loans meet or exceed FHA’s value in this regard.
High Mortgage Insurance Costs: Depends On Credit Score
If you have super-high credit, and a 5% down payment, conventional private mortgage insurance (PMI) could be cheaper than FHA mortgage insurance.
In just about every other scenario, FHA is cheaper.
Here’s an example using PMI rates from mortgage insurance provider MGIC compared to FHA mortgage insurance.
Monthly Mortgage Insurance, $300,000 Loan
FHA 3.5% Down
Conventional 5% Down
Buyers in all credit score ranges get the same mortgage insurance with FHA. Conventional PMI is risk-based, so those with lower credit might pay three times as much as someone with high credit.
In short, your decision between FHA or conventional as a first-time buyer could well be determined by your mortgage insurance cost.
Which Loan Is Better For You?
There’s no single right answer for every first-time buyer, except to compare both FHA and conventional to see which one works best for you.
Get started by requesting a rate and cost quote for both programs from a reputable lender.
Tim Lucas spent 11 years in the mortgage industry and now leverages that real-world knowledge to give consumers reliable, actionable advice. Tim has been featured in national publications such as Time, U.S. News, MSN, The Mortgage Reports, My Mortgage Insider, and more.