Before you can get a mortgage, your lender will determine how likely it is you as the buyer will fulfill your obligation to repay your mortgage. Borrowers who default on (or stop paying) their mortgage pose a serious risk to lenders.
The FHA or Federal Housing Administration guarantees they will reimburse the lender if a borrower defaults on their mortgage. That’s what lenders are referring when you hear terms like a “guaranteed” versus an “unguaranteed” loan.
Since FHA loans are guaranteed by the federal government, lenders can offer them with less stringent requirements.
Conventional mortgages are not backed by the government, so they have stricter qualifications to help ensure the homeowner doesn’t default.
That criteria “conforms” to Fannie Mae and Freddie Mac’s standards, which gives rise to the term “conforming loan”. These two federally sponsored programs will purchase loans that conform to their standards, which frees up capital so the lender can fund additional loans.
The differences between the two mortgages can be seen here:
|FHA Loan||Conventional Loan|
|Minimum Credit Score||500||620|
|Minimum Down Payment||
10% if credit score is 500
3.5% if credit score is 580
|3% - but can be higher depending on your situation|
|Income Requirements||None, but you must have at least two established credit accounts (ie credit card and car loan)||50% of lower debt-to-income ratio (DTI)|
|Mortgage Insurance Required||Yes, for the life of the loan||Yes, but can be canceled once the homeowner has 20% equity|
Buyers who opt for a conventional loan commonly (although not always) have to pay mortgage insurance until they build 20% equity in their home. Buyers who choose an FHA loan on the other hand will be paying for that insurance for the life of the loan, or until they refinance into a conventional loan.
Those are just some of the reasons why there’s no best first-time homebuyer mortgage. Every buyer must carefully consider their financial situation to determine the best option for them.