Conventional, FHA-insured, and VA-guaranteed loans are similar in that they're all issued by banks and other approved lenders. But some significant differences exist between these types of loans.
If you have a low credit score, you might want to look into getting an FHA-insured loan because other loans typically aren't available to those with bad credit. But if you have good credit, you might get more benefit from a cheaper conventional loan. If you're a current or former military servicemember, you should investigate getting a VA-guaranteed loan, which might be the least expensive of all three loan types.
Here's what you need to know about conventional, FHA-insured, and VA-guaranteed loans as of late 2020.
When you apply for a home loan, you can try for a government-backed loan, like an FHA-insured or VA-guaranteed loan, or a conventional loan, which isn't insured or guaranteed by the federal government. Unlike federally-insured loans, conventional loans carry no guarantees for the lender if you fail to repay the loan. For this reason, if you make less than a 20% down payment on the property, you'll probably have to pay for private mortgage insurance (PMI) when you get a conventional loan. If you default on the loan, the mortgage insurance company makes sure the lender is paid in full.
Conventional mortgages fall into one of two categories: conforming or nonconforming loans. Conventional conforming mortgage loans must adhere to guidelines that the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) set. These loans are available to everyone, but they're more difficult to qualify for than VA-guaranteed and FHA-insured loans. Because conventional loans don't have government insurance, these loans pose a higher risk for lenders. So, credit and income requirements are stricter than for FHA-insured and VA-guaranteed mortgages.
Generally, you can get a conventional conforming loan if you:
Other types of conventional loans, which aren't conforming, include jumbo loans, portfolio loans, and subprime loans.
As the name implies, an FHA-insured loan is a loan that the Federal Housing Administration (FHA) insures. If you default on the loan and your house isn't worth enough to fully repay the debt through a foreclosure sale, the FHA will compensate the lender for the loss. If you're behind in your mortgage payments on an FHA-insured loan, you get access to special loss mitigation options that specifically apply to borrowers with FHA-insured loans.
Because the loan is insured, the lender can offer you good terms, including a low down payment—as low as 3.5% of the purchase price. This type of loan is often easier to qualify for than a conventional mortgage, and anyone can apply. Borrowers with a FICO credit score as low as around 500 might be eligible for an FHA-insured loan. But FHA-insured loans have a maximum loan limit that varies depending on the average cost of housing in a given region. To learn more about FHA loan limits, visit the U.S. Department of Housing and Urban Development (HUD) website.
Most FHA-insured loans get approved by an automated system, while a few are referred to the lenders who manually review borrowers' applications based on FHA guidelines. In 2016, HUD eliminated a rule that required manual reviews for all mortgage applications from borrowers with credit scores under 620 and debt-to-income ratios above 43%. As of March 2019, however, the agency tightened the underwriting requirements for FHA-insured loans; too many risky loans were being made.
Now, around 40,000-50,000 loans per year—four to five percent of the total mortgages that the FHA insures on an annual basis—which would have previously been approved automatically will now be put through a more rigorous manual underwriting review, according to FHA officials.
Also, you'll have to pay a mortgage insurance premium or "MIP" as part of an FHA-insured loan. (Conventional mortgages have PMI and FHA loans have MIP.) The premiums that borrowers pay contribute to the Mutual Mortgage Insurance Fund. FHA draws from this fund to pay lenders' claims when borrowers default.
Again, as the name implies, a VA-guaranteed loan is a loan that the U.S. Department of Veterans Affairs (VA) guarantees. This type of loan is only available to certain borrowers through VA-approved lenders. The guarantee means that the lender is protected against loss if the borrower fails to repay the loan.
To get a VA-guaranteed loan, you must be:
To learn the specific eligibility requirements for a VA-guaranteed loan, go to the VA website.
These mortgage loans can be guaranteed with no money down with no private mortgage insurance requirement. Borrowers do, however, usually have to pay a funding fee—a one-time charge between around 1.25% and 3.6% of the loan amount. To learn more about VA-guaranteed loans, see the VA's Home Loan website.
Picking the right mortgage for your situation can be daunting. If you're having trouble figuring what type of loan is best for your circumstances or need other home-buying advice, consider contacting a HUD-approved housing counselor, a mortgage lender, or a real estate attorney.