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 loans through government programs, but the requirements to qualify 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 that are set by the federal government and by the government-sponsored enterprises known as Fannie Mae and Freddie Mac. Depending on your county, conforming loan limits are between $726,200 and $1,089,300 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 are above the maximum amounts mentioned above and may also include loans geared toward borrowers with poor credit or inconsistent income.
Government-backed loans, including FHA loans but also USDA and VA loans are considered non-conforming.
In common parlance, when people are talking about conventional mortgages, they usually mean conventional, conforming loans.
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View RatesFHA loans at a glance
As opposed to 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 the loans are insured by the FHA, private lenders are more willing to take on riskier borrowers.
For borrowers with poor credit who can't afford a big down payment, FHA loans tend to be more affordable than conventional loans. And the reverse is also true: Conventional loans might be cheaper for folks who have decent credit and can afford a down payment of, say, 10% or 15%.
Like conforming loans, FHA loans have limits as well. According to HUD, FHA loan limits range from $472,030 to $1,089,300 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 can vary by lender, but most lenders will 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 receive an FHA loan, you will need a credit score of at least 500, though 580 and above is highly preferable. If your credit score is under 580, not all lenders will accept you, and you will have to come up with 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 like to see a DTI ratio lower than 36%, and many lenders won’t even consider a ratio higher than 43%.
Borrowers looking for an FHA loan should have a DTI ratio of 43% or lower. 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 it, and that can drastically reduce your monthly mortgage payments.
FHA loans allow for down payments of 3.5% for borrowers with credit scores 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 that you have 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 referred to as private mortgage insurance, or PMI. FHA mortgage insurance is known as mortgage insurance premium (MIP).
Homebuyers with FHA loans have two different types of insurance costs: the upfront mortgage insurance premium as well as an annual premium paid monthly. The upfront portion is equal to 1.75% of the FHA loan and is due at the end of the sales process, which may hike up closing costs. The annual premium portion typically runs 0.55% to 0.75% of your mortgage balance.
Usually, private mortgage insurance (PMI) costs between 0.3% to 1.5% of the loan amount per year and is broken down into 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 a little more complicated 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 of 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 the risk is lower 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 cases of foreclosure.
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 commonly considered to be more thorough than appraisals for conventional mortgages.
While rare, some real estate agents of the home seller might recommend that the homeowner avoid buyers with an FHA loan due to the rigor of the FHA appraisal and the complications it could cause if certain issues with the home were unveiled. 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
- Loan is insured by the federal government
- Down payments as low as 3.5%
- Looser rules for borrowers' monthly income and credit score
- Rigorous appraisal process a boon for buyers
- Mandatory mortgage insurance premium(s)
- Can be more expensive for financially stable homebuyers
- Only available for primary residences
Conventional loan pros and cons
- Down payments can be as low as 0%
- No mortgage insurance (if down payment is 20% or greater)
- Mortgage insurance premium not due at closing
- Can be cheaper for financially stable buyers
- Stricter credit score, income and debt requirements
- Lenient property standards
- Mortgage rates tend to be higher
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 to people who have less-than-stellar credit. However, they’re not always the best idea for people with a more stable financial situation.
- Conventional loans are by far the most popular type of mortgage, but their strict loan requirements block some homebuyers out. 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.