It’s not always an easy choice. FHA and conventional loans are both widely available, and both can offer competitive mortgage rates.
FHA has typically been the mortgage loan of choice for buyers with less-than-perfect credit, smaller down payments and higher debt-to-income ratios.
But the tide is shifting. Conventional loan programs can also help buyers who don’t have a perfect credit profile save money.
Let’s compare these programs side by side to see which one would work best for you.
What is an FHA loan?
FHA loans have been making home-buying easier since the Great Depression. FHA stands for Federal Housing Administration, which is a government agency.
But the federal government does not lend you money when you get an FHA loan. Instead, the FHA insures your home loan. (If a borrower defaults on an FHA loan, the FHA covers the lender’s losses.)
So how does this government backing help home buyers? With FHA mortgage insurance behind your loan, a lender can offer lower interest rates even if you don’t make a huge down payment or have excellent credit.
In exchange for this extra security, you’ll pay FHA mortgage insurance premiums (MIP) — both upfront and each year for as long as you have the loan. Mortgage lenders add the cost of MIP to your monthly mortgage payment.
Despite this added cost for FHA mortgage insurance, an FHA loan could still save you money if it gives you a lower interest rate compared to a conventional loan.
What is a conventional loan?
A conventional loan does not come with insurance from a government agency. As a result, the borrower’s credit history, down payment size and debt-to-income ratio (DTI) can have a bigger impact on the loan’s mortgage rate.
Homeowners who buy with conventional loans still have to get mortgage insurance if they put less than 20% down. But unlike the FHA’s mortgage insurance, conventional private mortgage insurance (PMI) can be canceled once you’ve paid down the loan balance to 80% of your home value.
You no longer need a huge down payment to get a conventional mortgage with PMI. In fact, you could put less down on a conventional loan (3%) than the FHA’s minimum down payment requirement of 3.5%.
Even though the federal government does not insure conventional loans, it still influences how these loans work. Two government-sponsored enterprises, Fannie Mae and Freddie Mac, set the rules for conventional loans.
FHA vs. conventional loan requirements
A lot of buyers can decide between FHA vs. conventional borrowing by finding out which loan requirements they can meet.
Here are the numbers:
|FHA loans||Conventional loans|
|Credit score||580 with 3.5% down
500 with 10% down
|620 is the minimum credit score for most lenders|
|Down payment||3.5% is the minimum down payment for borrowers with credit scores of 580 or higher
10% is required with 500-579 credit scores
|3% is the minimum down payment possible|
|Debt-to-income ratio||43% is the maximum DTI for most lenders, but some will go as high as 50%||36%-43% is the DTI range for most lenders|
|Loan limits||$420,680 is the FHA loan limit in 2022 for most areas||$647,200 is the maximum loan size for 2022 in most areas. Limits go higher in high-cost areas|
|Mortgage insurance||1.75% of the loan amount added upfront, and
0.85% of the loan amount annually for a 30-year fixed loan
|0.5%-1.5% of the loan amount annually until the loan-to-value ratio (LTV) reaches 80%; not required with 20% down|
|Purpose||Primary residences only; will work for 2-, 3-, or 4-unit complexes if borrower lives in one of the units||Primary residences, second homes, vacation homes, investment properties|
Borrowers should remember these numbers are not always absolute, and the loan requirements can affect each other.
For example, borrowers who exceed requirements for DTI and down payment may be able to qualify even if they fall a few points short of the loan’s minimum credit score requirement.
For conventional loans, a borrower who barely meets the minimum credit score and DTI standards may need to make a larger down payment to qualify.
When does an FHA loan make sense?
An FHA loan makes sense for home buyers who won’t get a competitive rate on a conventional loan for one or more of the following reasons:
- Credit score is too low
- Debt-to-income ratio is too high
- The borrower needs to make a low down payment
The extra security of FHA insurance — which would protect the lender after a foreclosure — allows the lender to extend favorable mortgage rates even when borrowers are too risky for conventional lenders.
Yes, the cost of FHA mortgage insurance will continue throughout the life of the loan, unless the borrower puts 10% or more down. (In that case, FHA PMI expires after 11 years.)
But these FHA premiums become a good investment if you couldn’t buy a home without them.
And, borrowers can eliminate FHA PMI by refinancing out of their FHA loans later. Once the loan’s balance falls below 80% of the home value, a homeowner can refinance into a conventional loan with no private mortgage insurance.
When does a conventional loan make sense?
A conventional loan makes sense when the homebuyer has the credentials — the credit history and the down payment money — to score a lower mortgage rate without the FHA’s help.
When you look at the qualifying credentials for a conventional loan — a 3% down payment and a 620 FICO — they look attainable. But remember, these are the minimums for qualifying. Qualifying for a loan doesn’t mean you’ll qualify for a competitive interest rate.
An ideal conventional loan applicant looks more like this:
- A credit score above 680
- A debt-to-income ratio below 36%
- The ability to exceed the minimum down payment of 3%, while still paying closing costs
Depending on the lender, a borrower could need a credit score in the mid-700s or higher to qualify for a 3% down conventional loan with a low interest rate.
It works the other way around, too: Someone who has the minimum FICO score of 620 may need to put 8% or 10% down to get a competitive conventional loan rate.
But, if you can qualify for a low conventional rate, you’ll save compared to an FHA loan with the same rate, mainly because you won’t be paying the FHA’s 1.75% upfront mortgage insurance premium. Plus, your monthly mortgage insurance payments would eventually go away on their own.
FHA vs conventional loans for first-time homebuyers
Shoppers tend to associate FHA loans with first-time homebuyers, but this type of mortgage isn’t designed only for first-time buyers.
It just so happens first-time buyers often need the FHA’s backing because they haven’t had a chance to establish a good credit history or to save up a large down payment.
In reality, FHA loans can help anyone achieve homeownership, even home shoppers who have owned homes before, and even if they already own real estate (as long as the new home purchase will be their primary residence).
Conventional loans can help first-time buyers, too
Modern-day conventional loans also include loan options that can help first-time homebuyers and others who may struggle to qualify:
- Freddie Mac Home Possible: A 3% down loan that lets borrowers document income from co-borrowers who don’t live with them. This income boost helps buyers qualify for single-family home loans more easily. You’d need to earn 80% or less of your area’s median income to participate
- Fannie Mae HomeReady: This 3% down loan option lets you supplement your income with rent you receive from a roommate or boarder who will live in your home, boosting your loan eligibility
These special conventional loan options can help borrowers who need a little help qualifying. They provide an alternative to FHA loans and their permanent mortgage insurance premiums.
Even though these conventional options can help with income qualifying, they still require higher credit scores than FHA loans. Borrowers with lower credit scores — FICOs between 580 and 620 — will still do better with an FHA loan.
Variety of options adds to conventional loan appeal
Conventional loans include a wide variety of loan options. Along with the HomeReady and Home Possible loans for buyers who need help qualifying, most lenders can also offer:
- Conventional 97: Another 3% down loan option but with no income limits, unlike Home Possible and HomeReady
- Conventional 95: A 5% down loan that will require monthly mortgage insurance premiums. The higher down payment can lower mortgage rates and monthly payments, though
- Piggyback loan: These loans let you avoid monthly mortgage insurance even if you have only 10% to put down in cash. They work by pairing your 10% down with another 10% down from a second mortgage
- Jumbo loan: Also known as non-conforming loans, jumbo loans can exceed the conventional loan limit in your area and will usually require a larger down payment and a stronger credit profile
Conventional loans also offer more choices for loan terms when compared to FHA loans. FHA offers only 15- and 30- year terms while conventional loans can offer 10- and 20-year terms, along with 15- and 30-year terms.
Loan terms make a big difference in how much interest you’ll pay over the life of your loan. Shorter terms require higher monthly payments but less long-term interest.
Conventional loan vs FHA FAQs
What is an FHA loan?
An FHA loan is a type of mortgage in which the Federal Housing Administration insures the lender in case the borrower defaults. With FHA insurance protecting a lender, it can offer loans with lower interest rates even to borrowers with lower credit scores and low down payments.
What is a conventional loan?
A conventional loan does not have mortgage insurance from the federal government, unlike FHA, USDA, and VA loans. Instead, borrowers who put less than 20% down will buy private mortgage insurance to protect the lender. Conventional loans tend to cost less than FHA loans for borrowers with a strong credit profile.
What is a conventional loan vs FHA?
Home buyers often choose between conventional vs FHA loans because both these types of mortgages work for borrowers in all U.S. locations and for borrowers with any income. Federally backed USDA and VA loans, on the other hand, have additional criteria, such as military affiliation (VA loans) or rural locations and moderate-income levels (USDA loans).
Which is a better loan: FHA or conventional?
Both loan types have strengths and weaknesses. A better question is which loan is better for you as the borrower? If you couldn’t qualify for a conventional loan, or if your loan officer says your conventional loan rate would be significantly higher than an FHA rate, it’s best to go with an FHA loan, despite its higher mortgage insurance premiums.
What is the downside of a conventional loan?
Since the government does not insure conventional loans, borrowers have to qualify for low mortgage rates all by themselves. Borrowers who barely meet the minimum requirements for a conventional loan typically pay more than borrowers with excellent credit and a large down payment.
Why would you choose FHA over conventional?
Borrowers should choose an FHA loan when its mortgage rate is significantly lower than their best rate for a conventional loan (though make sure to factor in the additional cost of mortgage insurance premiums when comparing). Borrowers with average credit profiles and low down payments often find themselves in this financial situation.
Do sellers prefer conventional or FHA?
Sellers may prefer conventional loans, simply because the more rigorous standards and regulations with FHA financing can make the process more complicated. For example, the FHA does enforce minimum property standards. So a home with exposed lead paint, for example, wouldn’t pass the FHA’s inspection.
What is the advantage of an FHA loan over a conventional loan?
FHA loans help protect lenders from the risks of loaning money to home buyers with low down payments, higher DTIs, and lower credit scores. With a conventional loan, a lender would have to mitigate its risk by charging a higher interest rate. With FHA loans, lenders can offer lower mortgage rates even to higher-risk borrowers.
Are FHA loans more expensive than conventional?
For a borrower who could qualify for a competitive mortgage rate on a conventional loan, an FHA loan would cost more because of its higher mortgage insurance premiums. However, for a borrower who’d pay a higher rate on a conventional loan, an FHA loan could cost less, even with the higher insurance premiums. If you’re not sure where you stand, ask a loan officer to break down the costs for you.
FHA vs conventional: The best option depends on the borrower
Borrowers with great credit, good income, and money in the bank should seriously consider using a conventional loan instead of an FHA loan. For this type of borrower, it doesn’t make a lot of sense to incur the extra expense of an FHA loan.
However, borrowers who have had credit issues in the past or have limited assets may qualify for FHA financing only. After all, the FHA loan program exists to allow people to buy homes who normally wouldn’t be able to.
Talk to your mortgage professional to determine which option is better for you. If you qualify for both loan programs, have your loan officer draw up personalized scenarios taking into consideration initial costs and ongoing costs.
With your two options in black and white, you’ll be able to make a great educated decision whether FHA or conventional financing makes the most sense for your home buying goals.