In most scenarios, homebuyers would be priced out of affording new properties if home loans did not exist. Only the wealthiest individuals can afford the upfront price of a home, especially since the average cost of a home in the United States is over $400,000. For this reason, most buyers will take out a mortgage loan to finance their pursuit of homeownership.
Buyers have several options for home loans. The common types are FHA loans, VA loans, and traditional loans. In this guide, we will discuss the differences between conventional and FHA loans and which sellers prefer when negotiating with buyers.
What Is The Goal of a Home Seller?
Most sellers have similar goals for their properties. They want to sell the home for more than they paid to earn a decent profit. Additionally, they want to sell the house quickly to relieve that burden. Finally, the seller wants to sell the home to a reliable buyer who will not back out of the sales process.
Understanding the sellers’ perspective is important if you are in the market to buy a home. It could give you a leg up on other buyers, and if your offer aligns with their goals, the seller may accept it.
What Is a Conventional Loan?
A conventional loan is the most common mortgage product on the market. Buyers will borrow money from a lender and then pay back the principal loan balance plus interest over a certain period, often 15, 20, or 30 years.
Several types of conventional home loans exist that you can choose from as a buyer. What makes this type of loan different from others is that it is not backed by a government agency.
Conventional financing is available to most borrowers, but some conventional loan requirements might put them out of reach for lower-income borrowers or those with poor credit scores.
Types of Conventional Loans
Conventional loans are perfect for those with decent income and a good credit score. There are three different types of conventional loan products that you can use to finance your home purchase, including;
- Jumbo loans – If the cost of your home is beyond the limits set by Fannie Mae and Freddie Mac (which are overseen by the Federal Housing Finance Agency), your conventional loan is considered a jumbo loan
- Adjustable rate loans – This loan comes with adjustable interest rates that shift with the mortgage market, potentially causing changes to your monthly payment amount over time
- Fixed-rate loans – With this conventional mortgage, your interest rate is locked in, so the monthly mortgage payment does not shift during the lifetime of a fixed-rate loan
What Is an FHA Loan?
An FHA loan is a non-conventional loan amount available to certain buyers, insured by the Federal Housing Administration (FHA), making it a government-backed loan. Because of this insurance, banks and credit unions can offer FHA loans with lower qualification standards than conventional mortgage requirements.
In general, an FHA loan is designed to assist borrowers with fewer resources who may not meet the qualifications for a conventional loan. This criteria includes individuals with lower credit scores, lower down payments, or higher debt-to-income ratios.
Comparing Conventional and FHA Loans
There are significant differences between conventional and government loans. As a buyer, you should understand a few key differences between these loan types, as they will impact which one is better suited for your needs.
Loan Requirements
Many conventional loan lenders also offer other products, like FHA loans. For example, you can apply for either product from F5 Mortgage. Whether you qualify for an FHA loan, a conventional loan, or both depends on the following requirements.
Credit Score
Credit scores reflect a borrower’s ability to pay back their debts. A higher credit score reflects a strong credit history and a reliable borrower. For most conventional loans, you must have a minimum credit score of 620, though it depends on the type of traditional loan you are getting. For example, a jumbo loan is riskier for the lender to give out and will require higher credit scores, so you would need a score of 680 or more to be approved.
FHA loans can be approved even with a lower credit score. At F5 Mortgage, the minimum credit score for an FHA loan is 580. This number makes homeownership more accessible to those with shorter credit histories or numerous debt obligations.
Down Payment
A down payment is money paid upfront by the borrower toward the home’s purchase price. The greater the down payment amount, the less the principal of the loan amount will be owed.
Conventional Loans: Conventional loans generally require a down payment of at least 3-3.5%. For jumbo loans, which are higher-value loans, the minimum down payments increase to 10%. The recommended down payment for conventional loans is 20%, allowing borrowers to avoid paying a private mortgage insurance premium (PMI).
FHA Loans: An FHA loan has minimum down payment requirements similar to a conventional loan that is not a jumbo mortgage. The minimum requirement for an FHA loan is 3.5%, which is only slightly higher than the minimum for conventional loans. Down payments tend to be smaller with FHA loans because borrowers are generally purchasing less expensive homes. You will also need to pay an upfront mortgage insurance premium (UFMIP) for your FHA loan.
Debt-to-Income Ratio (DTI)
Debt-to-income ratios (DTI) are metrics that lenders use to assess the risk of a particular borrower. They measure a person’s monthly debt obligations versus their monthly income. Conventional loans have a maximum DTI requirement of 50%. To get a jumbo conventional loan, the required DTI is 45% or less.
FHA loans are more forgiving with a borrower’s DTI. Though the maximum amount can vary depending on other financial circumstances, you might be able to secure an FHA loan with a DTI of 57% or less.
Closing Costs
Closing costs are extra fees that must be paid between the home buyers and sellers when the transaction is completed. They include attorney fees, loan origination fees, transfer taxes, realtor commissions, and more. Both FHA and conventional loans have similar amounts for closing costs.
In general, the buyer will pay between 3-6% of the total cost of the home in closing costs. Sellers usually pay a little more because of the commission fees for the real estate agents, which could bump closing costs up to 6-10%.
In some cases, borrowers with FHA loans might be able to get sellers to cover more of the closing costs since the buyer’s resources are limited. Additionally, you may need to pay mortgage insurance premiums when you close if your loan does not meet the mortgage insurance requirements.
Other Factors
As you can see, there are numerous differences when comparing FHA loans to conventional financing. From the buyer’s perspective, there are more variations to consider when choosing a loan product.
Appraisal Process
Appraisals are professional inspections of a property conducted by the local appraiser. They ensure that the property’s actual value matches the price it is being sold for. A conventional appraisal is much quicker, and there is more flexibility regarding discrepancies between the sales price and the appraised value.
An FHA appraisal will take longer because FHA loans are government-backed loans. This appraisal means the property is scrutinized more closely to ensure it meets certain criteria for safety and is worth what it is being sold for.
Buyer Profile
The buyer’s background also influences whether they choose conventional loans or FHA loans. Generally, a more reliable buyer will take out a conventional mortgage because they meet the stricter requirements and can afford it.
If you have limited financial resources or cannot meet the minimum credit score, your ability to get a conventional loan will be impacted. In that scenario, you are more likely to qualify only for an FHA loan.
Market Conditions
The state of the local real estate market will also impact your prospects and the type of loan you can obtain. In a buyer’s market, which is the state of most areas in the country right now, you have more freedom to choose the best option for yourself. However, if you are looking in a seller’s market, then you will have to be far more competitive and may be stuck with a certain type of loan product.
Current interest rates will also affect your loan amount. If you have a better credit score and pay a larger down payment, you can access better interest rates with conventional loans and FHA loans.
Property Type
FHA loan limits are stricter than those for conventional loans. Since the government insures the mortgage, you cannot use it to purchase a luxurious home. In lower-cost areas, the maximum amount for FHA loans is about $420,000, while the limit in high-cost markets is $970,000.
Conventional mortgages do not have these limits. You can technically get conventional loans for any price. However, there is a limit that impacts the type of conventional loan you can get. The conforming loan limit (set by Fannie Mae and Freddie Mac) is currently $766,550 on average, though that number varies from market to market. These loan limits only differentiate between conforming conventional loans and jumbo loans.
Why Do Sellers Prefer Conventional Over FHA Loans?
Typically, sellers prefer conventional loans over FHA loans because of the ease with which a transaction can go through with a conventional mortgage. Let’s look at the top reasons why a conventional loan will set you up well in the eyes of the seller.
Smoother and Faster Closing
Conventional loans are the most common product on the market for home financing, so they are the simplest to deal with when closing. Since sellers usually want to get things done quickly, the extra delays caused by FHA loans are less appealing.
For example, the appraisal process is much quicker with conventional loans, so dealing with a buyer who requires FHA loans is far less appealing because of the timeline.
Reduced Seller Concessions
Buyers and sellers usually negotiate over price during a home transaction. Since the government-backed loan has a stricter appraisal process, there are more likely to be seller concessions.
Conventional buyers usually need fewer concessions than FHA buyers. This negotiation can result in a smaller profit for the seller once the sale is completed, incentivizing them to seek buyers who will use conventional mortgages instead.
Higher Financial Strength of The Buyer
In terms of financial strength and the differences between FHA vs conventional borrowers, conventional loans tend to be safer bets for sellers. If the buyer can afford a conventional home loan, they probably have a better income, a stronger credit score, and fewer debt issues.
This loan-to-value ratio is usually a good indicator of whether the transaction will go through. Whether fair or not, many sellers see those who use FHA loans as financially weaker, so they may hesitate to negotiate with those buyers.
Summary
Both conventional loans and FHA loans can help you buy your next home. Even though sellers may have preferences for the types of borrowers they will deal with, it doesn’t mean purchasing a home with an FHA loan is harder. F5 Mortgage can help you understand what FHA loans require and which loan program best fits your situation.
Get a free quote today, or call us at 888-459-0483 to learn more about our home financing loan types. If you have questions about what FHA loans require, how much private mortgage insurance premiums are, or what other government financing, also known as non-conventional loans, is available, we will be happy to provide the answers.
