FHA vs. Conventional Loans: Pros, Cons and Requirements

So you want to buy a home — congratulations. Now, the million-dollar question is: How are you going to pay for it?

Given that homes are one of the most expensive purchases we make, chances are high that you aren't going to pay for it all in cash. So you’ll need to take out a home loan, aka a mortgage, to finance it.

There are several types of mortgages available to homebuyers, and in this guide, we’re going to walk you through the ins and outs of two of the most popular options: conventional loans and FHA loans.

Table of contents

• Conventional loans at a glance
• FHA loans at a glance
• FHA vs. conventional loans: overview of requirements
• Other key differences between conventional and FHA loans
• FHA vs. conventional loan FAQs
• Summary of FHA vs. conventional loans

Conventional loans at a glance

Conventional loans are mortgages that aren’t backed or insured by a government agency, such as the Department of Veterans Affairs (VA) or the Federal Housing Administration (FHA). By a wide margin, conventional loans are the most popular type of mortgage, according to the nonprofit Urban Institute.

Typically, conventional loans cost less than FHA loans or other government-backed loans, but qualifying requirements can be more onerous. They often require a good credit score and down payment, making them a solid option for those in good financial standing.

Conventional mortgages come in two flavors: conforming and non-conforming loans.

Conforming loans have loan limits and other rules set by the federal government and the government-sponsored enterprises Fannie Mae and Freddie Mac. Conforming loan limits in most areas are between $832,750 and $1,249,125 for single-family homes, according to the Department of Housing and Urban Development (HUD).

By contrast, non-conforming loans are mortgages that don’t meet Fannie Mae and Freddie Mac’s guidelines. The features of these loans can vary from lender to lender. Non-conforming loans can include jumbo loans that exceed the maximum amounts mentioned above and may also include loans for borrowers with poor credit or inconsistent income.

Government-backed loans, including FHA, USDA, and VA loans, are considered non-conforming.

In common parlance, when people are talking about conventional mortgages, they usually mean conventional, conforming loans.

FHA loans at a glance

Unlike conventional conforming loans, FHA mortgages are insured by the federal government, though they are issued by private mortgage lenders.

These types of loans can be a lifeline for those with less-than-stellar credit or limited money for a down payment. Since FHA-insured loans are backed by the FHA, private lenders are more willing to accept riskier borrowers.

For borrowers with poor credit who can't afford a large down payment, FHA loans are often more affordable than conventional loans. And the reverse is also true: Conventional loans might be cheaper for people with good credit and who can afford a down payment of, say, 10% or 15%.

Like conforming loans, FHA loans have limits. According to HUD, FHA loan limits range from $541,287 to $1,249,125 for single-family homes, depending on your county.

FHA vs. conventional loans: overview of requirements

Aside from these broad differences, the core distinctions between FHA loans and typical conventional loans boil down to financial qualifications of the borrower. Here’s a look at the various credit score, debt and down-payment requirements for both types of loans.

Credit score requirements

For a conventional loan, you’ll need a decent credit score to meet the minimum qualifications. Credit score requirements vary by lender, but most require a minimum credit score of 620. To get a more attractive rate or to qualify for a lower down payment, a much higher credit score is typically needed: Think 740 or higher.

To qualify for an FHA loan, you will need a credit score of at least 500, though 580 or higher is preferred. If your credit score is below 580, not all lenders will approve you, and you will need a larger down payment.

Debt-to-income ratio requirements

Simply put, your debt-to-income ratio — aka DTI ratio — is the percentage of your gross income that goes toward paying down debts. So the lower the percentage, the better. Your DTI ratio is an important factor in qualifying for a mortgage.

For conventional mortgages, lenders prefer a DTI below 36%, and many won’t consider a ratio above 43%.

Borrowers seeking an FHA loan should have a DTI of 43% or less. In some cases, FHA-loan lenders may be willing to consider a ratio higher than that if you can show that you have ample savings or additional income from side gigs or bonuses.

Down payment requirements

Traditional personal finance rules say you’ll need to pay 20% of the home’s purchase price upfront in the form of a down payment to get a mortgage. But the reality is that most homebuyers don’t put that much down. In fact, the National Association of Realtors estimates the typical down payment for first-time homebuyers is 8%.

Conventional loan lenders often have a minimum down payment requirement of 3% for first-time buyers, though it's possible to find lenders willing to go to 1% — or even 0% down, so long as you have a good credit score. Of course, putting 20% down is an option if you have the funds, and it can significantly reduce your monthly mortgage payments.

FHA loans allow for down payments of 3.5% for borrowers with credit scores of 580 and above. If your credit score is below that, you may be required to make a down payment of 10% or more.

Other key differences between conventional and FHA loans

Here’s where else FHA and conventional loans differ.

Mortgage insurance

If your down payment is less than 20%, your lender will likely require mortgage insurance for a conventional loan. With an FHA loan, mortgage insurance is mandatory regardless of the size of your down payment.

Before going further, let’s tackle some quick definitions. Mortgage insurance for conventional loans is called private mortgage insurance (PMI). FHA mortgage insurance is known as a mortgage insurance premium (MIP).

Homebuyers with FHA loans have two types of insurance costs: an upfront mortgage insurance premium and an annual premium paid monthly. The upfront portion is 1.75% of the FHA loan amount and is due at the end of the sales process, which may increase closing costs. The annual premium portion typically runs 0.55% to 0.75% of your mortgage balance.

Private mortgage insurance (PMI) typically costs between 0.3% and 1.5% of the loan amount per year and is paid in monthly installments.

Mortgage insurance policies protect the lender — not you — in the event that you default on your monthly mortgage payments.

It’s possible to get rid of mortgage insurance by refinancing your mortgage, though you’ll want to carefully weigh the costs of refinancing versus the cost of insurance premiums. You may also be able to refinance an FHA loan into a conventional loan for the same reason.

If you don't refinance, then conventional mortgage PMI can usually be canceled once you’ve built up 20% home equity.

It’s slightly more complex for FHA loans. If you put down less than 10% with an FHA loan, you will be stuck with the monthly premiums for the life of the loan. However, if your down payment was 10% or more, the mortgage premiums will stop after 11 years.

Mortgage rates

Many factors affect mortgage rates, such as the state of the economy and the benchmark interest rates set by the Federal Reserve. For a standard 30-year fixed-rate loan term, average rates have been stuck above 7% lately.

That said, your personal finances are another factor in that equation. And you can find rates lower than that on different types of mortgages, such as a 15-year mortgage or an adjustable-rate mortgage. These other types of loans are available for both conventional and FHA.

Since FHA loans are insured by the government — and thus carry lower risk for lenders — FHA mortgage rates tend to be slightly lower than conventional loans.

Appraisal process

No matter the type of loan you’re getting, your lender will likely require an appraisal of the home. An appraisal seeks to determine the loan-to-value ratio, or LTV.

In other words, the appraiser calculates the home’s value to ensure that the loan the lender is cutting for the property does not exceed the value of the home. An accurate LTV ratio helps protect the lender in foreclosure proceedings.

In some instances, the appraisal can be waived for conventional mortgages. For FHA loans, an appraisal is almost always required and must be completed by an FHA-approved appraiser. FHA appraisals are often considered more thorough than conventional mortgage appraisals.

While rare, some real estate agents representing the home seller might recommend that the homeowner avoid buyers with FHA loans due to the rigor of the FHA appraisal and the complications it could cause if certain issues with the home are revealed. The appraisal typically comes toward the end of the homebuying process, and issues that could arise late in the game may force the seller to go back to square one.

FHA vs. conventional loans: pros and cons

Here's a quick snapshot of the pros and cons of FHA and conventional loans for homebuyers.

FHA loan pros and cons

Conventional loan pros and cons

FHA vs. conventional loan FAQs

Summary of Money's FHA vs. conventional loan guide

• FHA loans and conventional loans are two of the most popular types of mortgages.

• FHA loans can help expand homeownership for people with less-than-stellar credit. However, they’re not always the best option for people with more stable financial situations.

• Conventional loans are by far the most popular type of mortgage, but their strict loan requirements exclude some homebuyers. These types of loans may be better suited for people with credit scores of 720 or above.

• Neither loan is a clear winner, and you may end up with multiple loan options. When deciding, be sure to factor in your mortgage rate, down payment size and mortgage insurance costs.