FHA Vs. Conventional Loan: 8 Important Differences to Consider
9 MIN READ
Published October 06, 2023 | Updated November 09, 2023
When purchasing a home, the type of mortgage you get will determine the type of home you can purchase, qualification requirements, terms, and interest rates. For most homebuyers, the two main options are conventional loans and FHA loans. FHA-approved lenders offer loans backed by the Federal Housing Administration. These loans allow lower credit scores and smaller down payments.
Conventional loans can be harder to qualify for, but they typically cost less, especially if you can put down at least 20% to avoid paying mortgage insurance. Knowing the key differences between FHA vs. conventional loans can help you determine which type of mortgage will be best for you.
What Are FHA Loans?
FHA loans are mortgages insured by the Federal Housing Administration. These government-backed loans are nonconforming loans, which means that you don’t have to meet the lending standards set for conventional loans. Government agencies do have their own qualification standards, but these are less stringent. If you have a lower credit score or do not have a larger down payment, an FHA loan may be a good choice for you. FHA loans are available as adjustable-rate mortgages (ARMs) or fixed-rate mortgages.
What Are Conventional Loans?
Conventional loans are mortgages that are not government-backed. You’ll typically need a higher down payment, a lower debt-to-income ratio (DTI), and a higher credit score to qualify for these mortgage loans. Conventional loans are available as fixed-rate or adjustable-rate mortgages and repayment terms can be from 8 to 30 years.
8 Key Differences of FHA vs Conventional Loans
Understanding the differences between FHA vs. conventional loans will make it easier for you to determine which type of mortgage will work best for your unique situation. Both types of loans are good options and suitable for different types of borrowers.
|FHA Loan||Conventional Loan|
|Credit scores||At least 580 with a 3.5% down paymentAt least 500 with 10% down payment||At least 620|
|Down payment||At least 3.5%||3% for first-time home buyers, minimum 5% in other cases|
|Debt-to-income ratio||Maximum of 50%, with a down payment of 10% or more, or significative liquid assets in reserve||Maximum of 43%|
|Loan limits||$472,030 in most areas||$726,200 in most areas|
|Mortgage insurance||An upfront and ongoing mortgage insurance premium (or MIP) is required on loans with less than 20% down. Insurance may be unremovable, depending on the property's loan to value ratio and other property factors.||Mortgage insurance required on loans with less than 20% down. Removable once you reach 20% home equity|
1. Eligibility: Credit Score and Income
Qualifying for an FHA loan is easier than a conventional loan. With an FHA loan, you may be eligible even with a credit score of 500 if you have a 10% down payment. For a 3.5% down payment, the minimum credit score requirement is 580. With conventional loans, lenders will typically require you to have a credit score of at least 620. The higher your credit score, the better terms you may get. For example, getting a home loan with a 650 credit score will be easier than getting one when you have a credit score of 620.
There are no set monthly income requirements with mortgages, but lenders will look at your debt-to-income ratio to determine your eligibility. For FHA loans, you may be able to qualify with a DTI of 50% if you have cash reserves and good credit scores. You’ll also need to demonstrate a stable job history.
With conventional loans, the maximum DTI you can qualify with is 43%. There may be exceptions in some cases if you have higher credit scores or mortgage reserves.
2. Down Payment
With an FHA loan, you’ll need a 10% down payment if your credit score is 500-579. If your credit score is over 580, you’ll need a 3.5% down payment. If you’re applying for a conventional loan and want to forgo private mortgage insurance (PMI), you’ll need a 20% down payment. First-time homeowners can put down as little as 3% to get a conventional loan. If you’re not purchasing your first home and if your income is less than 80% of the median income in the area, the minimum down payment limit is 5%. For a second home, the lower limit is 10%.
3. Interest Rates
FHA loans have lower interest rates than conventional loans. However, the total cost of the loan will depend on a number of factors. For example, if you’re putting down less than 10%, you’ll need to pay mortgage insurance. This additional fee can make the mortgage more expensive. Even if you put down over 10%, you’ll still need to pay insurance for at least 11 years. If you think you’ll reach 20% equity in less than 11 years, a conventional loan may be a better option because the mortgage rate savings with an FHA loan may not be worth it.
4. Mortgage Insurance
Regardless of whether you get an FHA loan or a conventional loan, you’ll need to pay mortgage insurance if you don’t have a 20% down payment. They’re typically paid through your monthly mortgage payment.
With an FHA loan, you’ll need to pay an upfront mortgage insurance premium of 1.75% of the loan amount. Then, you’ll pay a premium annually depending on the amount you borrow, loan term, and down payment size. FHA mortgage insurance premiums (MIP) cannot be canceled. You must continue to pay it over the life of the loan unless you refinance. If you put down at least 10%, the insurance can be canceled after 11 years.
With a conventional loan, the mortgage insurance can be canceled once you have 20% equity in the home. you can do this by refinancing, getting an appraisal if the value of your home has increased, or making extra payments to reduce your total loan balance.
5. Government Backing
Another major difference between an FHA vs. conventional loan is that an FHA loan is backed by the Federal Housing Administration (FHA). A government agency backs it and has its own lending standards that are different from conventional loans.
Government agencies do not back conventional loans. Conforming loans follow the rules set by federal regulators, but they’re not required to do so. Only those loans that conform to those rules are purchased by Fannie Mae and Freddie Mac.
6. Closing Costs
Compared to conventional loans, FHA loans have higher closing costs. However, FHA loans allow the property seller to pay for more of the closing costs so they may end up being cheaper in some cases. For example, the seller can pay 6% of the closing costs, regardless of the down payment amount. On the other hand, if you’re putting down less than 10%, outside parties can only pay 3% of the closing costs. If you’re low on cash reserves, FHA loans may be a better choice.
7. Restrictions on Property Type
When comparing FHA vs. conventional home loan options, the intended use and condition of the property you plan to buy are important factors. Compared to conventional appraisals, FHA appraisals are stringent. The home’s value is determined, and it’s thoroughly checked for adherence to local code, soundness of construction, and safety.
With conventional loans, appraisals are more focused on the market value of the property. The quality of the home is evaluated with a home inspection, which is not a mandatory requirement but is recommended. You’ll only be able to get an FHA loan for a primary residence, not for investment properties. Conventional loans can be used for any purpose.
8. Loan Limits
The maximum loan amount you can borrow through an FHA, or a conventional loan will vary by regulations and county. For 2023, the maximum FHA loan limit is $472,030 in low cost areas and $1,089,300 for high-cost areas.
The Federal Housing Finance Agency sets the loan limits for conventional loans. For most areas in the U.S., the maximum loan limit is $726,200 for 2023. Mortgages over that limit are known as jumbo loans and may be subject to stringent standards.
Which Is Better for First-Time Homebuyers?
If you’re buying a home for the first time, an FHA loan can be easier to qualify for. FHA loans are also a better choice if you have a lower credit score. If you have enough money to put down 20%, a conventional loan may be a better option because it will allow you to avoid paying mortgage insurance and present yourself as a strong candidate in the housing market. If you’re not sure what type of loan will be best for you, speak to a mortgage lender with information about your specific financial situation.
“Sellers might refuse an offer from an FHA loan-backed buyer because they believe they lack the financial resources to get them to closing without issue or incident along the way,” Brad Reichert, founder and managing director of Reichert Asset Management, explains. “What sellers often don’t know is, a pre-approval on an FHA loan is just as good as a pre-approval on a conventional mortgage, and FHA borrowers historically have a closing rate that is on-par with conventional buyers,” Reichert adds.
Making an Informed Decision
Every situation is different, but if you have a credit score of over 620, have a low DTI, and a down payment of at least 3% (20% if you don’t want to pay PMI), a conventional loan may be your best bet. An FHA loan may be a better choice if you have a lower credit score, have a higher DTI, and don’t have a lot of money for a down payment. Ultimately, the right type of loan will be based on your unique situation and needs. Weigh the pros and cons of both loan programs and understand your own qualifications to make an informed decision.