What is the Difference Between a Conventional Loan and a FHA Loan?

Peter Bieda The Mortgage Expert
January 13, 2022 - 5 min read

Many homebuyers are often confused when shopping for a home loan and the difference between Government Versus Conventional Loans. There are different options on the type of home mortgage borrowers can get. There are times when a borrower may qualify for a government loan but not a conventional loan.

Each loan program has its own agency mortgage guidelines. Loan officers can go over the various types of home mortgage loan programs that are available and which loan program best benefits you. We will go over the difference between Government Versus Conventional Loans For Home Buyers in this article. Besides government and conventional loans, there are non-QM mortgages. Non-QM loans are alternative mortgage programs geared towards benefiting borrowers who do not qualify for government and/or conventional loans.

What Are Government-Backed Mortgages

There are three different types of government-backed loans:

• FHA
• VA
• USDA

The government does not originate, process, underwrite, and fund home mortgages.

• So what are government loans?
• Why do they call these loans government-backed loans?

They are called government loans because these mortgages are backed by a government agency. The U.S. Department of Housing and Urban Development (HUD) is the parent of FHA. HUD is the federal agency through FHA that governs FHA loans. HUD creates and launches the agency mortgage guidelines for FHA loans. Private lenders originate, process, underwrite, and fund FHA loans. HUD will insure and partially guarantee private lenders against the losses in the event borrowers default and foreclose on their FHA loans.

However, in order for HUD to insure lenders against losses sustained on borrower default and foreclosure, the lender needs to follow all aspects of HUD Agency Guidelines on FHA loans.
HUD will not insure lenders who did not follow HUD Agency Guidelines. This concept holds true on VA and USDA loans. The Veterans Administration is the federal agency that administers VA loans.
The U.S. Department of Agriculture USDA Rural Development is the federal agency that administers USDA loans.

Due to the government guarantee, lenders are more than happy to offer homebuyers government-backed loans with little to no money down at competitive mortgage rates.

 Understanding Conventional Mortgages

Conventional loans are not backed by any government agency. Private lenders originate, process, underwrite, and fund conventional loans. Lenders will fund conventional loans using their own funds through their warehouse line of credit. Once the loan funds, lenders need to sell funded loans on the secondary market. Fannie Mae and Freddie Mac are the two major mortgage giants in the United States.

The role of Fannie Mae and Freddie Mac is to provide liquidity in the mortgage markets by purchasing loans funded by private lenders. Fannie Mae and Freddie Mac are the two largest buyers of mortgages in the United States. However, Fannie Mae and Freddie Mac will only purchase mortgages that conform to their agency mortgage guidelines. This is why conventional loans are often referred to as conforming loans. Lenders need to sell loans they fund on the secondary market.

The proceeds from the loans, they sell on the secondary mortgage market are used to pay their warehouse line of credit. The warehouse line of credit needs to be paid so they can originate and fund more loans. This is how the overall mortgage process works.

Agency Mortgage Guidelines On Government And Conventional Loans

Government and conventional loans have their own agency mortgage guidelines. Each loan program is different with regard to the down payment requirements, maximum debt-to-income ratio, and waiting period after bankruptcy and/or foreclosure. Lenders will require borrowers to meet the minimum agency requirement. However, lenders can have higher lending requirements that is above and beyond the minimum agency mortgage guidelines called lender overlays.

For example, the minimum credit score requirement to qualify for a 3.5% down payment FHA loan is 580 FICO. However, a lender can require a 620 credit score requirement on FHA loans even though the minimum HUD Agency Guideline is 580. This higher credit score requirement is called lender overlays on credit scores imposed by the lender. Lenders can have lender overlays on just about anything.
This is why not all lenders will have the same lending requirements on FHA, VA, USDA, and Conventional loans. Just because you get denied by one lender does not mean you cannot qualify for a mortgage from a different lender. Capital Lending Network, Inc. is one of a few mortgage companies with zero lender overlays on government and conventional loans.

CLN Mortgage Group just goes off the automated findings of the automated underwriting system (AUS) with no lender overlays.

Lender Overlays Imposed By Mortgage Lenders

As mentioned earlier, all lenders need to have their borrowers meet the minimum agency mortgage guidelines. However, most lenders will have lender overlays on government and conventional loans. Lender overlays are higher lending standards than the minimum agency mortgage guidelines. This is why it is very important borrowers, especially folks with less than perfect credit, understand the basic mortgage agency guidelines.

There are lenders like Capital Lending Network, Inc. that has no lender overlays on government and conventional loans. We will cover the most common lender overlays imposed by lenders.

Common lender overlays are the following:

• Most lenders will require a higher credit score than the minimum agency lender overlays.
• For example, VA does not require a minimum credit score requirement.
• However, most lenders will require a 620 or higher credit score requirement.
• This is called a lender overlay on credit scores.
• VA does not have a maximum debt-to-income ratio cap as long as they get an approve/eligbile per automated underwriting system (AUS).
• However, most lenders will have a cap on debt to income ratio on VA loans.
• VA and FHA loans allow for manual underwriting.
• However, there are many lenders that will not do manual underwriting.
• Other lenders will have a credit score cap if they are getting gift funds for the down payment and/or closing costs.
• FHA and VA allow borrowers in Chapter 13 bankruptcy repayment plan to qualify for a mortgage without the bankruptcy being discharged.
• However, there are many lenders that do not accept borrowers who are in the Chapter 13 Bankruptcy repayment plan.
• There is no waiting period requirements after the Chapter 13 Bankruptcy discharge date to qualify for an FHA or VA loan.
• However, there are many mortgage companies that will require a one-year or two-year waiting period requirement after the Chapter 13 Bankruptcy discharge date.

There are countless lender overlays lenders can impose. It is perfectly legal for mortgage companies to have additional higher lending requirements than the minimum agency mortgage guidelines. Remember that just because one lender says NO does not mean you do not qualify for a mortgage. Capital Lending Network, Inc. has no lender overlays on government and conventional loans.