The two most common types of loans popular for first-time homebuyers.
Conforming and FHA loans are the most popular among homebuyers. According to the National Association of Realtors’ 2021 Generational Trends Report, these types of loans account for 80% of all mortgages. Determining which type of loan is right is dependent upon your financial status and goals. Both types of loans have their pros and cons and different qualification requirements. Here’s what you need to know:
What is an FHA Loan?
An FHA loan is a government-insured loan issued by the Federal Housing Administration, an agency that encourages affordable homeownership. They are designed for low-to-moderate-income home buyers – and as such, they require a down payment of 3.5% (for 1-4 unit homes) for those who have a credit rating of at least 580. But this number spikes to 10% for those who have a credit rating between 500-579. You can use an FHA loan to finance a primary home. Unlike conventional loans, you cannot purchase a second home, rental home, vacation home, or investment property.
Know Your Options – Common Types of FHA Loans
The FHA offers several loan options, from traditional to ones that meet specific needs (e.g., FHA 203(k)). Here’s an overview:
Basic Home Mortgage: A mortgage used to finance a primary residence, as either a fixed-rate or adjustable-rate mortgage.
Rehabilitation Mortgage: The loan allows borrowers to finance a home in repair, modernizations, or renovations. The cost must be at least $5,000. The types of rehabilitation include but are not limited to: adding or replacing floors, landscape and work improvements, and structural alteration and reconstruction.
Energy Efficient Mortgage: The loan allows borrowers to finance energy-efficient upgrades or improvements, such as replacing a furnace or cooling system, insulating an attic, or installing active and passive solar technologies. The cost of improvements must be the lesser of: 5% of the property’s value, 115% of the median area price of the home, or 150% of the conforming loan limits set annually by the FHFA.
Graduated Payment Mortgage: The loan allows borrowers with limited income to make low initial payments that’ll gradually increase over time, along with their earning potential. It has negative amortization – the amount you owe will increase because you’re not paying enough to cover the interest.
Growing-Equity Mortgage: The loan allows borrowers with limited income to make low monthly payments that’ll increase over time. Any amount beyond an amortizing payment is applied directly to the remaining principal, shortening the life of the loan and increasing overall interest savings.
Home Equity Conversion Mortgage or Reverse Mortgage: The loan allows homeowners aged 62+ to withdraw and convert a portion of their home’s equity into income or a line of credit. Homeowners are required to take consumer education and counseling pending approval.
Title I Property Improvement Loan: The loan allows borrowers to finance a home in need of property improvements, repairs, and rehabilitation of up to $25,000. Renovation projects can include but are not limited to replacing plumbing or heating system, making the home disability-accessible, and installing or replacing appliances.
Construction to Permanent Loan or One-Time Close Loan: The loan allows borrowers to combine the purchase of the land, construction of a home, and mortgage financing into one loan. If you already own the piece of land, you can use the value of that land purchase as the down payment.
What are the Loan Limits?
FHA loans have a maximum loan amount that the government will insure, referred to as a floor and ceiling limit. In other words, if you’re looking to buy a home that exceeds the ceiling limit for your county, you’ll be required to pay the difference as your down payment. Here are FHA Loan limits for 2023*:
FHA Loan Limits for 2023 | ||
Number of Units | Floor Loan Limit | Ceiling Loan Limit |
Single-Family | $472.030 | $1,089,300 |
Two-Family | $604,400 | $1,394,775 |
Three-Family | $730,525 | $1,685,850 |
Four-Family | $907,900 | $1,867,275 |
*High-cost areas such as Alaska, Hawaii, and Guam have considerably higher ceilings.
What’s a Conforming Loan?
Conforming loans are often erroneously confused as conventional loans. Though a conforming loan is a conventional loan, not all conventional loans are conforming loans. Conforming loans are used to finance homes that are within federal loan limits. They require a down payment as low as 3% (even lower than FHA loans) and a minimum credit rating of at least 620. If you have a credit rating lower than 620, you won’t qualify. You can use this type of loan to finance a primary and secondary home, as well as an investment property.
Know Your Options – Common Types of Conventional Loans
There aren’t any different types of conforming loans available – but there are conventional loans. Here’s an overview:
Conforming Conventional Loans: A loan that doesn’t exceed the national loan limits set by the Federal Housing Finance Agency (FHFA) for standard-cost and high-cost areas.
Non-conforming (Jumbo) Conventional Loans: A loan that exceeds the national loan limits set by the Federal Housing Finance Agency (FHFA) and is used to finance high-cost or luxury properties.
Non-qualified Mortgages: A loan that uses non-traditional methods of income verification to help borrowers who don’t meet the qualifying criteria to finance a home.
Portfolio Loans: A loan that a lender originates and retains instead of selling it to the government-sponsored enterprises, Fannie Mae and Freddie Mac. These loans are typically available to those who don’t meet the qualifying criteria set by the FHFA.
Subprime Conventional Loans: A loan that’s issued to borrowers with a 600 or less credit rating, a DTI ratio greater than 50%, or who are self-employed at a high-interest rate.
HomeReady® Loan: A loan designed by Fannie Mae to help credit-worthy, low-to-moderate income borrowers become homeowners. Unlike conforming loans, you can have a DTI as high as 50% and fund your entire down payment with gift funds (applicable for single-unit family homes).
Home Possible® Loan: A loan designed by Freddie Mac to help credit-worthy, low-to-moderate income borrowers and have similar qualifications as a HomeReady® loan. There is no minimum borrower contribution for single-unit homes nor counts non-borrower income as a compensating factor.
Piggyback Loan or 80/10/10 Loan: A loan that allows borrowers to use two mortgages simultaneously. The first mortgage comprises 80% of the home price, the second mortgage covers 10%, and the remaining 10% goes towards the down payment.
What are the Loan Limits?
The government-sponsored enterprises, Fannie Mae and Freddie Mac, set the annual conforming loan limits. Limits vary by state, district, or territory and number of units. Those that exceed the following loan limits are considered jumbo loans. Here are the residential loan limits for 2023:
FHFA Loan Limits for 2023 | ||
Number of Units | Standard-Balance | High-Balance |
Single-Family | $726,200 | $1,089,300 |
Two-Family | $929,850 | $1,394,775 |
Three-Family | $1,123,900 | $1,685,850 |
Four-Family | $1,396,800 | $2,095,200 |
Takeaway
In sum, there are some key differences:
FHA vs. Conforming Loans | ||
FHA Loan | Conforming Loan | |
Minimum Down Payment Requirement | 3.5%* | 3% |
Minimum Credit Score Requirement | 580* | 620 |
Maximum Debt-to-Income (DTI) Ratio | 50% | 43% |
Types of Home to Finance | Primary | Primary, Secondary, Investment |
Mortgage Insurance | MIP required regardless of down payment.** | PMI required if down payment less than 20%. |
*A 500 credit rating requires a 10% down payment, whereas a 580 credit rating requires a 3.5% down payment. **If you put less than 10% down, you'll have to pay MIP over the life of the loan. If you have 10% or more, you'll be stuck with MIP for 11 years. | ||