Conventional and FHA loans are two of the most popular types of home loans. You’ll likely come across these terms as you prepare to buy a home or refinance your mortgage.
The main difference between an FHA loan and a conventional loan is that an FHA loan comes with a lower credit score requirement and a more flexible debt-to-income ratio (DTI) requirement. But that’s not the only thing that sets these two loan types apart.
Let’s take a closer look at the difference between FHA and conventional loans and how to decide which one is right for you.
How Does An FHA Loan Work?
An FHA loan is a home loan backed by the Federal Housing Administration (FHA), a government agency created to help home buyers qualify for a mortgage. The FHA provides backing on loans made by FHA-approved lenders to help provide loans to borrowers who need more lenient loan requirements.
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How Does A Conventional Loan Work?
Conventional loans are the most common in the mortgage industry. They’re funded by private financial lenders and then often sold to government-sponsored enterprises like Fannie Mae and Freddie Mac on the secondary mortgage market. Conventional loans aren’t directly backed by a government agency and have stricter qualifications for borrowers.
Differences Between An FHA And A Conventional Loan
Thanks to more lenient credit requirements and a higher maximum DTI, FHA loans are a common option for first-time home buyers. They’re also suitable for anyone who needs lower credit requirements to get a mortgage. However, more lenient requirements don’t mean that FHA loans are right for everyone.
Before you choose a mortgage, let’s take a look at the pros and cons of each.
Why Consider A Conventional Loan?
A conventional loan is a great option if you have a solid credit score and a low DTI. Conventional mortgages are also a popular choice for home buyers making a down payment of 20% or more.
That’s because paying more upfront means lower monthly payments and avoiding paying private mortgage insurance (PMI). Don’t worry, if you’re unable to make a large payment upfront you still have options. Conventional loans are available with a down payment as low as 3%. Plus, you can always remove PMI when you reach 20% equity in your home.
Why Consider An FHA Loan?
FHA loans are generally easier to qualify for because of their lower credit score and DTI requirements. While conventional loans may not require mortgage insurance with a large enough down payment, FHA loans come with mandatory mortgage insurance premiums. However, this extra cost allows lenders to continue offering FHA loans to borrowers with imperfect credit histories or past financial issues.
FHA Vs. Conventional Loan: Terms, Conditions And Requirements
Choosing the best loan option for you depends on your financial situation. By evaluating the requirements for each type of mortgage, you can determine which one best fits your needs.
Let’s take a look at some of the terms, conditions and requirements for FHA versus conventional loans.
FHA Loans | Conventional Loans | |
|---|---|---|
Minimum Credit Score | 580 or higher | 620 or higher |
Minimum Down Payment | 3.5% for credit scores above 580 (10% for 500-579) | As low as 3% |
Maximum Debt-To-Income Ratio | Typically 43% or lower, up to 57% with certain qualifications | 50% or lower |
Mortgage Insurance | Mortgage insurance premiums: upfront and monthly | Private mortgage insurance if down payment is less than 20% |
Loan Limits | Varies by location; As low as $472,030 or as high as $1,089,300 for a one-unit property | Varies by location; $726,200 in most areas for a one-unit property or as high as $1,089,300 in high-cost areas |
Property Standards | FHA loans can only be used on primary residences. | Conventional loans can be used on any type of residence. |
Interest Rates | FHA loans offer competitive interest rates. | Conventional loan rates depend on the borrower’s qualifications (credit score, occupancy, etc.). |
Refinance Process | FHA Streamline Program is the most straightforward FHA option. Cash-out refinances are also available. | Rate-and-term and cash-out refinances are available. |
Let’s take a deeper look at credit score requirements, debt-to-income ratios, mortgage insurance, loan limits and property standards, as well as interest rates and refinances when it comes to FHA loans versus conventional loans.
Conventional Loan Vs. FHA Loan Minimum Credit Score
Whether you apply for an FHA loan or a conventional loan, your lender will take a close look at your credit score. The strength of your credit informs the lender of the relative risk of mortgage default.
FHA Loan Credit Score Requirements
It’s possible to get an FHA loan with a lower credit score than with other types of loans. With many mortgage lenders, you can qualify with a median score as low as 580. If you have a score of 620 or higher, you may be able to qualify even with a slightly higher debt-to-income ratio.
The FHA backs loans with a qualifying FICO® Score of 500 or better. But if your score is under 580, you need a 10% down payment. Lenders who offer these loans may charge a higher interest rate.
Conventional Loan Credit Score Requirements
Conventional loans have stricter requirements than FHA loans. You’ll need a higher credit score – a minimum of 620 – to qualify for a conventional loan than you would with an FHA loan.
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FHA Mortgage Vs. Conventional Loan Debt-To-Income Ratio
Your debt-to-income ratio (DTI) is the percentage of your monthly gross income compared to your monthly debt payments. Lenders use this number to determine how much income you have to cover your monthly mortgage payments. To qualify for a home loan, your DTI will need to be below a certain threshold.
FHA Loan DTI Requirements
FHA lenders typically require a DTI of 43% or lower. Some lenders may allow a DTI up to 57% based on the borrower’s overall profile.
Conventional Loan DTI Requirements
Freddie Mac and Fannie Mae set the maximum DTI at 50% for conforming loans. Most lenders will also accept DTIs below 50%. If you have a higher DTI, you might need to take the time to lower your ratio to qualify for a conventional loan.
It’s also worth noting that to qualify for the lower interest rate, you’ll want to keep your DTI at or below 40%.
FHA Vs. Conventional Mortgage Insurance
Mortgage insurance is an insurance policy that protects the lender if the borrower is unable to continue making payments. Let’s take a look at what mortgage insurance is required for both FHA and conventional loans.
FHA Loan Mortgage Insurance Premiums
To offset a lower required credit score, FHA loans include mortgage insurance as part of the borrower’s responsibility.
FHA loans require two types of mortgage insurance payments:
- An upfront mortgage insurance premium (MIP) of 1.75% of the loan amount, either paid when you close on the loan or rolled into the loan amount.
- A monthly MIP as part of your regular mortgage payments.
If your down payment was less than 10%, you’ll continue to pay monthly mortgage insurance for the life of the loan. If your down payment was 10% or more, you’ll only have to pay mortgage insurance for the first 11 years of the loan before it’s removed.
Conventional Loan Private Mortgage Insurance
Private mortgage insurance (PMI) is a type of mortgage insurance unique to conventional loans. Like mortgage insurance premiums do for FHA loans, PMI protects the lender if the borrower defaults on the loan.
You’ll have to pay PMI as part of your mortgage payment if your down payment was less than 20% of the home’s value. Unlike mortgage insurance for FHA loans, PMI offers three different payment options.
Borrower-Paid PMI
Borrower-paid PMI, or BPMI, does not require an upfront cost. Depending on the lender or mortgage investor, you can typically request to have it canceled once you’ve reached 20% equity in your home. In most cases, it’s automatically removed once you reach 22% equity.
Lender-Paid PMI
Lender-paid PMI, or LPMI, is paid for you by your lender. The lender will raise your mortgage interest rate to incorporate the insurance payment they make on your behalf. This option may result in lower payments, but it’s typically not cheaper over the life of the loan. LPMI can’t be canceled because it’s built into your interest rate.
Single-Pay PMI
A third option is single-pay mortgage insurance. Under this scenario, a client pays for all or part of their mortgage insurance policy upfront in order to have lower monthly mortgage insurance fees or none at all, regardless of their down payment.
Conventional Mortgage Vs. FHA Loan Limits
FHA and conventional loans both come with limits for the amount you can borrow. The loan limit for either loan largely depends on where in the U.S. you want to buy your home.
FHA Loan Limits
The FHA determines its lending limits based on the area you want to live in and the type of property you plan to purchase. FHA loan limits in most counties are generally less than with conventional loans. FHA loan limits can range from $472,030 up to $1,089,300 in some high-cost areas.
Conventional Loan Limits
Conventional loans come with a standard loan limit for the area where you want to live and typically offer more than an FHA loan. If you need a loan that exceeds those limits, you may want to consider a jumbo loan. The limit for a one-unit property in most areas is $726,200. However, you may see loan limits as high as $1,089,300 depending on where you purchase your home.
FHA Loan Vs. Conventional Loan Property Standards
When deciding between an FHA or conventional loan, it’s important to consider how you plan to use the property.
FHA Loan Property Standards
To qualify for an FHA loan, the property must act as your primary residence. FHA loans aren’t available for second homes or investment properties. FHA loans also have stricter appraisal standards.
Conventional Loan Property Standards
Unlike FHA loans, a conventional loan can be used to purchase a secondary home like a vacation home or investment property.
Conventional Loan Vs. FHA Loan Interest Rates
Your mortgage rates will largely depend upon the factors discussed above, as well as your choice between an adjustable-rate mortgage (ARM) or a fixed-rate mortgage.
FHA Mortgage Rates
The decreased risk for the lender generally means competitive interest rates for an FHA loan borrower. In other words, your interest rate may be lower with an FHA loan than with a conventional mortgage.
Keep in mind that mortgage lenders will be looking at your complete borrower profile to determine your rate. Rates will be influenced by outside factors like the state of the economy and the Federal Reserve’s effect on mortgage interest rates.
Conventional Mortgage Rates
Just like FHA loans, conventional mortgage interest rates will fluctuate with the market and with the fed rate. Though it’s difficult to quantify all the factors that affect how mortgage rates are determined, focusing on your own finances can help improve your interest rate.
Here are some of the specific factors that lenders consider when determining your interest rate:
- Down payment amount
- Credit rating
- Debt-to-income ratio
You may be able to purchase mortgage discount points at closing to decrease your overall interest rate. Points can decrease your rate, but potential savings depend heavily on how long you plan to stay in the home if you think you may refinance.
When it comes to interest rates, having your finances in good shape is the best way to decrease your overall rate.
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FHA Loan And Conventional Loan Refinances
Both conventional and FHA loans can be refinanced in a variety of different ways, but let’s take a look at the simplest option for either loan type. You can also take cash out during a refinance, but qualification requirements could be stricter.
FHA Streamline Program
FHA loans have another advantage. The FHA Streamline program allows you to refinance an FHA loan without some of the costs or steps needed for other types of refinances.
This refinance option allows you to lower your monthly payments or interest rate faster because it doesn’t require a complete credit check or income verification. Often, an appraisal is not required. However, the FHA Streamline refinance limits the closing costs that can be rolled into the new mortgage amount.
Conventional Mortgage Rate-And-Term Refinance
If a homeowner with a conventional mortgage wants to change their interest rate or loan term without converting equity into cash, they can use a rate-and-term refinance.
This type of refinance is fairly straightforward, like an FHA Streamline, and can help reduce the borrower’s monthly payment. Unlike an FHA Streamline, a rate-and-term refinance does require an appraisal to confirm the property’s market value.
FHA Vs. Conventional Loan FAQs
Learn more about FHA and conventional home loans with the answers to these commonly asked questions.
What is a conventional loan versus an FHA loan?
An FHA loan is a mortgage backed by the Federal Housing Administration. This type of loan uses lower interest rates and less strict credit score requirements. Conventional loans are not backed by a government agency and often use conforming loan limits.
While both FHA and conventional loans come with benefits, you should compare their requirements to find the best fit. You can also use our mortgage loan calculator to help see which loan will better serve your financial needs.
Can I switch from an FHA loan to a conventional loan?
Yes, you can refinance your FHA loan into a conventional mortgage. However, you should keep in mind that conventional home loans typically use higher credit score requirements. If you’re planning to refinance to a conventional loan, make sure to check your credit score first.
How much of a down payment do I need for an FHA loan?
FHA loans require a minimum down payment of 3.5% of the purchase price. If you have a credit score between 500 and 579 you may be required to put 10% down to qualify.
The Bottom Line
FHA loans are a popular mortgage option because of their low credit score requirements and competitive interest rates. On the other hand, conventional loans come with removable PMI payments and more occupancy options. To find the best option for your situation, carefully consider the pros and cons of each one.
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