FHA vs. Conventional Mortgages: How to Find Acceptance Even with Weak Credit

piggy bank faced with a maze

Mortgage loans are like power tools: You get the best results by using the right one for the job at hand. For many borrowers that may mean bypassing the conventional route to find the one that fits your budget today and is the least likely to cause financial stress in the future.

Affordability and the Federal Housing Administration (FHA) Program

For a borrower having trouble pulling together a down payment or who may have a weak credit history—or no credit history—an FHA mortgage effectively levels the playing field. The program was designed to open up homeownership to as wide a group of borrowers as possible, even those who may have experienced some financial missteps, like a foreclosure or bankruptcy, in their recent past.

What most borrowers don't realize is that the FHA doesn't actually issue mortgages. The agency provides insurance on the payments for the issuing lender. This insurance helps make an application more attractive for a lender to approve since it addresses any concerns the lender might have regarding repayment.

Why You Might Want to Do This

It's natural to think a government program would result in more paperwork and hassle than going the conventional route. FHA loans do require extra forms, but on the lender's side of the transaction, not yours. Better yet, qualifying for an FHA loan is only slightly more cumbersome than applying for a conventional mortgage.

Here are some other things you should know about FHA mortgages:

Benefits and Drawbacks for an FHA Borrower

Previously, FHA mortgages offered the added advantages of lower down payments and higher borrowing limits over conventional mortgages. Today, Conventional loans can be made with as little as 3 percent down, and borrowing limits are now the same for both loan types at $625,500. Another advantage FHA mortgages offer is that they are still eligible for a "streamlined" refinancing at a lower interest rate. Now that regulatory changes have greatly lengthened the refinancing procedure for conventional mortgages, this aspect can save time and money. FHA mortgages can also make a property more attractive on resale since they are assumable by the new owner, unlike a conventional loan.

Never Assume

The impact FHA insurance premiums have on the overall cost throughout the life of mortgage usually makes a conventional mortgage cheaper in the long run. Even when a conventional mortgage carries insurance, more commonly referred to as "private mortgage insurance (PMI)", PMI is only required until the borrower’s equity in the home reaches 20 percent. If you are only expecting to stay in your home for a few years, the FHA mortgage can be the better bet, even with the insurance.

With so many moving parts making up each loan, always have your lender run a comparison across all of the mortgage programs available to you. There is no reason your mortgage shouldn’t provide a custom fit to your current circumstances and your long-term plans.

How low will your payment be?