FHA vs. conventional loans: What’s the difference?
October 19, 2023 6 min read
When you’re looking to take out a home loan, it’s a good idea to understand the different types of mortgages. The eligibility requirements and amount you can borrow can vary with each loan, so the type of mortgage you get can impact your home search. FHA loans and conventional loans are two popular choices, whether you’re a first-time homebuyer or are buying your second or third property.
Read on to learn more about these loans.
FHA loans are insured by the Federal Housing Administration while conventional loans aren’t backed by any government agency.
FHA loans come with lower credit score and down payment requirements than conventional loans, but they require mortgage insurance and an FHA-approved appraisal.
Conventional loans have higher credit score standards and require larger down payments than FHA loans, but they come with higher loan limits and don’t require mortgage insurance.
What is an FHA loan?
An FHA loan is a mortgage that’s insured by the Federal Housing Administration and is available at many private banks and credit unions. It comes with lower down payment and credit score requirements compared to some other mortgage programs. These factors often make FHA loans appealing to homebuyers with less-than-perfect credit scores or relatively little savings.
What is a conventional loan?
A conventional loan is a mortgage that isn’t insured by a government agency, and it is also available at many private banks and credit unions. Conforming conventional loans follow certain rules set by the government and the Federal Housing Finance Agency (FHFA). Nonconforming loans, which include jumbo mortgages, do not follow FHFA rules. The major difference between the two is the borrowing limit.
What are the differences between FHA and conventional loans?
Some of the key differences between FHA and conventional loans include the following:
Credit score requirements
You may qualify for an FHA loan with a minimum credit score of either 500 or 580, depending on the size of your down payment. The minimum credit score for a conforming conventional loan is 620. However, some lenders set higher minimums for both FHA and conventional home loans.
Minimum down payment
With an FHA loan, your down payment can be as low as 3.5% if you have a credit score of at least 580. You’ll need to put down at least 10%, though, if your credit score is between 500 and 579. Some conforming conventional loans allow you to put down 3%, but lenders may set a higher minimum down payment.
Down payments are a pretty big expense. For example, if you want to buy a home that costs $300,000 and put down 3.5%, you’d need to save up $10,500. If you’re struggling to save that amount, look for a lender that accepts down payment assistance programs. These programs offer grants or low-cost loans to cover the up-front expenses of buying a home, such as the down payment and closing costs.
Your debt-to-income (DTI) ratio tells a lender how much of your monthly income goes toward debt payments. You may qualify for a conventional loan with a DTI ratio of up to 50%, while FHA loans allow a DTI ratio of up to 45%.
Each mortgage program sets a limit for the maximum amount you can borrow. In most parts of the U.S., an FHA loan for a single-family home in 2023 can go up to $472,030. Limits rise to $1,089,300 in high-cost areas and can go up to $1,633,950 in Hawaii and Alaska.
The conforming conventional loan limit for a single-family home in 2023 is $726,200 in most parts of the U.S. In high-cost areas, the limit increases to $1,089,300.
Mortgage insurance is a type of policy that protects the lender in case the borrower defaults on their mortgage payments. If you put down less than 20% on a conventional home loan, you’ll typically need to pay for private mortgage insurance (PMI). You can get rid of PMI once your mortgage reaches a loan-to-value ratio of 80%.
All FHA loans require two types of mortgage insurance: up-front and annual. When you close on the FHA loan, you’ll pay an up-front mortgage insurance premium that’s equal to 1.75% of the base loan amount. You can roll the premium into your loan if you don’t have the funds up front.
Your lender will also charge an annual mortgage insurance premium that ranges from 0.45% to 1.05% of the loan amount. The premium will be split into 12 installments and wrapped into your monthly mortgage payments.
Mortgage interest rates
Lenders set the interest rates on both FHA loans and conventional loans. Those rates are affected by the overall economy and factors like your loan term, loan amount and whether the interest rate is fixed or adjustable. Lenders also consider your credit scores and down payment amount when setting rates.
Pros and cons of FHA loans vs. conventional loans
Every mortgage program comes with benefits and drawbacks, which you’ll need to weigh before choosing your type of home loan. Here are the main pros and cons of FHA and conventional loans:
Potential pros and cons of FHA loans
Low minimum credit score requirements
Low down payment requirements
No maximum income limits
Lower borrowing limits than other mortgage types
Mortgage insurance is required
Requires an FHA-approved appraisal
Potential pros and cons of conventional loans
Higher borrowing limits than other mortgage types
Mortgage insurance isn’t necessarily required
No maximum income limits
Higher credit score requirements than other mortgage types
May require a higher down payment than other mortgage types
FHA vs. conventional loan FAQ
What is the downside of an FHA loan?
One of the major downsides of an FHA loan is the up-front and annual mortgage insurance. There’s only one way to remove mortgage insurance from an FHA loan. For example, if you took out the loan after June 3, 2013, and made a down payment of at least 10%, you can cancel the annual mortgage insurance premium after making payments for 11 years.
Another downside to FHA loans is the loan limit. Conventional loans may go up to $726,200 in most parts of the U.S., while FHA loans only stretch to $472,030. Both loans allow you to borrow more in high-cost areas.
Why would someone get an FHA loan instead of a conventional loan?
It’s generally easier to qualify for an FHA loan compared to a conventional loan. Depending on the size of the down payment, a borrower needs a credit score of either 500 or 580 to get an FHA loan. Conforming conventional loans require a score of at least 620.
FHA vs. conventional loans in a nutshell
FHA and conventional home loans are two options to consider when you’re looking to get a mortgage.
The main difference between the two is the credit score you need in order to qualify. FHA loans generally come with looser requirements, so someone may decide to pursue this loan if they have less-than-perfect credit. Conventional loans have higher loan limits, so someone may choose this type of mortgage if they need to borrow more and have a stronger credit history.