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FHA vs. Conventional Loans - What Are The Differences?

FHA and conventional loans are the two most popular loan options available to nearly every buyer. While it’s commonly expected that the FHA loan is for first time homeowners and that conventional options are reserved for experienced buyers with more capital, both loans have viable benefits for any type of buyer.

What Is A FHA Loan?

An FHA loan is insured by the Federal Housing Authority, which backs mortgage lenders to incentivize accessible loan options. This loan option is accessible to buyers with lower credit scores and offers down payments as low as 3.5%. Since it is a government-backed loan, the FHA loan has strict requirements about property type and condition and can only be used for a primary residence.

What Is A Conventional Loan?

A conventional loan is not backed by a government agency like the FHA. Instead, it’s offered by lenders who each set down payment and interest rate requirements based on national guidelines. A conventional loan provides more flexibility for borrowers with good credit scores or cash for more significant down payments and requires less additional fees like mortgage insurance. Conventional loans can be used for many different property types, like vacation homes or multi-families.

Comparing FHA & Conventional Loans

FHA and conventional loans have their own benefits and drawbacks. Each option has different requirements when it comes to loan limits, down payments, and borrower credit score. Choosing the best option for you depends on your financial situation and history.

Minimum Credit Score

FHA loans are great options for buyers with lower credit scores. With a credit score of 580 or higher, borrowers will only need to pay down 3.5% of the home price (which means that a home price of $225,000 would require a down payment of $7,875 before closing costs). Borrowers with credit scores as low as 500 can still qualify with a higher down payment of around 10%.

Conventional loans are best for borrowers with higher credit scores: most lenders look for a minimum score of 620. The better your credit, the lower your down payment, which is excellent news for borrowers who don’t have much in savings but have an excellent credit history.

Mortgage Insurance

Both the FHA and conventional loans require a form of mortgage insurance, but the requirements and fees differ with each option.

An FHA loan requires borrowers to pay a mortgage insurance premium (or MIP) for the duration of the loan. MIP rates fall between .45 – 1.05% annually, and a one-time upfront premium of 1.75% is required as well.

Conventional loans offer more flexible options when it comes to mortgage insurance. When homeowners make a down payment lower than 20%, mortgage insurance (PMI) requires the form of monthly payments without an upfront premium. Once the homeowner pays down 20% of their home value, the PMI lifts and is no longer required, lowering the monthly payment.

Loan Limits

Each loan type has its own limit on the amount of money that can be borrowed. The Federal Housing Finance Industry regulates conventional loan limits. Moreover, these limits can fluctuate a little each year, running at $548,250 for 2021. FHA loan limits vary based on the median home prices in each area. If you’re buying in a cheap area, the loan can be as low as $356,352. In more expensive areas, loans can reach $822,375.

Interest Rates

A lot of things can influence your interest rates. These things can be a combination of personal factors, including your credit history, debt-to-income ratio (DTI), and your down payment. Conventional loan rates depend on these factors more heavily than the FHA loan.

While this enables FHA loans to offer lower interest rates, borrowers with excellent credit, DTI, and higher down payment amounts might get a competitive rate with a conventional loan.

Down Payment

A low down payment is most often associated with the FHA loan, however, both loan options provide low down payment opportunities depending on a borrower’s circumstances.

As mentioned earlier, the FHA loan offers a low down payment option of 3.5%. If you have a low credit score, lenders might ask for more money down. Borrowers can finance with a conventional loan at 3%, but only with excellent credit history and a low DTI ratio. If you want to avoid mortgage insurance, you’ll have to pay 20% down with a conventional loan.

Reasons To Go With an FHA Loan

The FHA loan is generally the more accessible option for a mortgage. It allows borrowers with a lower credit score and savings the opportunity of a lower interest rate. The FHA loan also takes into consideration the area where you live, allowing you to borrow based on the market value of the neighborhood.

A FHA loan is a great option for those with a low credit score. It’s also great for when your debt-to-income ratio does not meet conventional loan requirements.

Reasons To Go With a Conventional Loan

Conventional loans bring more flexibility; and allow you to put more money down to avoid monthly PMI payments. If you have substantial credit and can put down more cash, a conventional loan may be ideal. This is because a conventional loan will keep your monthly payments low and doesn’t always require a high down payment. It can also be applied to different types of properties, like a vacation home or an investment property.

Conventional and FHA Loan Options

Choosing between a conventional and FHA loan depends largely on your financial situation. Both options appeal to different desires that each borrower has. If you need to put less money down and want a low interest rate, the FHA loan is for you. On the other hand, if you have good credit and you’re looking for more flexibility in your loan terms, a conventional loan may be the better option.

 

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This page last updated: May 12, 2022