Key Differences Between Conventional and Government Home Loans

Purchasing a home is likely the biggest financial decision you’ll make in your lifetime. With home prices continuing to rise across the country, securing financing is more important than ever for making homeownership attainable. When exploring your mortgage options, you’ll primarily choose between conventional loans offered by private lenders or government-backed loans through agencies like the Federal Housing Administration (FHA).

While both loan types have pros and cons, there are some significant differences between conventional and government loans to understand as you shop for a mortgage:

Government-Backed Loans

Government home loans are insured by agencies like the FHA, Department of Veterans Affairs (VA) or the U.S. Department of Agriculture (USDA). Because they are backed by the government these loans offer more flexible underwriting guidelines and down payment options for borrowers who may not qualify for conventional financing.

Some of the key attributes of government loans include:

• Lower credit score requirements – FHA loans allow credit scores as low as 500 while VA and USDA have no minimum score. Many conventional loans require scores of 620 or higher.

• Lower down payments – FHA allows down payments as low as 3.5%. VA and USDA require 0% down for those who qualify. Conventional loans typically need at least 5% down without mortgage insurance.

• Mortgage insurance – Government loans require upfront and annual mortgage insurance premiums to offset the risk of default. Conventional loans only need mortgage insurance if your down payment is less than 20% of the purchase price.

• Specialized programs – VA and USDA loans offer specialized programs for veterans, military members, and low-to-moderate income borrowers in rural areas. Conventional loans are more widely available.

• Property type – Government loans can only be used to finance primary residences where you plan to live. Conventional loans allow more flexibility for financing vacation homes or investment properties.

• Loan limits – Most government loans have maximum conforming loan limits in the range of $400,000 to $700,000. High-balance loans up to $1 million may be available in pricier markets. Conventional loan limits mirror these ranges but can sometimes go higher.

Conventional Loans

Conventional home loans are offered by private lenders like banks, credit unions, or mortgage companies without government backing. Given the lower-risk pool of borrowers, conventional loans typically have stricter eligibility standards but come with some advantages:

• Higher credit scores – A minimum FICO score of 620 is usually required for conventional loans, with scores of 700+ securing the best terms. Some lenders may accept scores in the 500s with strong compensating factors.

• Larger down payments – Conventional loans generally require down payments of at least 5-10% of the home’s price if you want to avoid mortgage insurance. 20% down or more is ideal.

• No mortgage insurance requirements – Conventional loans only require private mortgage insurance if your down payment is less than 20% of the purchase price, protecting the lender from default.

• More flexibility – Conventional loans allow more options for financing second homes, investment properties, jumbo loans above conforming limits, and unique situations.

• Wider availability – Conventional financing is offered by lenders nationwide as long as you meet eligibility criteria. Government programs may have specialized geographical or borrower requirements.

• No usage restrictions – You can use a conventional loan to purchase any type of residential property. Government loans are limited to primary residence occupancy.

How to Choose the Right Loan Type

When deciding between conventional vs government loans, there are a few key factors to consider:

• Down payment amount – The more you can put down, the more likely you are to qualify for a conventional loan. Government loans allow much lower down payments.

• Credit history – Your credit score plays a major role. In general, aim for conventional loans if your score is 620+ and government loans if your score is below 620.

• Debt-to-income ratio – Your total monthly debt payments, including the future mortgage payment, should not exceed 45% of your gross monthly income for conventional loans. Government loans allow ratios up to 55%.

• Type of property – Government loans can only be used to purchase a primary residence to live in. Conventional loans offer more flexibility for financing second homes or investment properties.

• Loan amount needed – If you need a jumbo loan higher than conforming limits, a conventional loan is likely your only option. Government loans have lower maximum amounts.

• Intended occupancy – Again, conventional loans allow for financing non-owner-occupied investor and vacation properties. Government loans are for primary residences only.

Shop Multiple Loan Options

Your loan officer can help you determine if you’re better suited for a conventional or government home loan based on your financial profile and the property you wish to purchase. Be sure to compare multiple quotes side-by-side, as interest rates, fees, and lender requirements can vary significantly. Ask your lender to provide a Loan Estimate for each loan type you are considering.

Running the numbers with tools like mortgage calculators for both conventional and government loans can illustrate the differences in monthly payments, interest costs, and other factors.

While government loans offer more flexible underwriting for borrowers who may not meet conventional guidelines, they come with the cost of mortgage insurance. On the other hand, conventional loans provide lower rates and longer terms for borrowers with strong credit and down payments but have stricter approval criteria.

Other Key Differences to Note

Beyond the major factors above, here are some other key differences between conventional and government home loans:

• Interest rates – Government loans may have slightly higher interest rates due to the higher-risk borrower pool. Strong credit can still secure low rates for both loan types.

• Loan terms – Conventional loans go up to 30 years. Government programs cap terms at 30 years for FHA and USDA, and 15 years for VA.

• Mortgage insurance – Government loans have required upfront and annual mortgage insurance premiums. Conventional loans just require private MI if down payment is under 20% until you reach 20% equity.

• Homebuyer education – First-time homebuyers are required to complete counseling for FHA loans and encouraged for VA loans. Conventional loans have no such requirement.

• Closing costs – Government loans may feature slightly lower closing costs and fees overall. However, conventional loans avoid the upfront mortgage insurance premium.

• Home standards – Properties financed with FHA loans are subject to minimum quality standards and appraisalrepair requirements. Conventional loans are more flexible.

• Prepayment penalties – Government loans do not allow prepayment penalties. Conventional loans may include penalties for paying off the balance early in the first few years.

• Assumability – FHA loans can potentially be assumed by a new buyer if you need to sell. Conventional loans are rarely assumable.

Which Loan Type is Right for You?

As you can see, government and conventional loans have clear tradeoffs. Conventional loans offer better terms and rates for borrowers with strong credit profiles and down payments. But government loans open the door to homeownership for those who may not meet conventional underwriting standards through benefits like low down payments and more lenient credit policies.

Be sure to get pre-approved by multiple lenders and compare loan estimates side-by-side. Look beyond just interest rates to factors like fees, required down payment, mortgage insurance, and loan limits.

If your credit score is below 620, you have limited funds for a down payment, or you don’t meet debt-to-income requirements for conventional loans, then an FHA, VA, or USDA loan likely makes sense. Otherwise, conventional financing may be the optimal route to help you achieve homeownership.