If you’re planning on buying a home of your own, you’re likely researching financing options. Two popular types are FHA loans and conventional mortgages. FHA loans are insured and regulated by the Federal Housing Administration, while conventional loans are not generally backed by the government.
Information about mortgages can be overwhelming, so you may be confused about FHA vs. conventional loans and how they work. If that’s the case, this guide might help you understand the differences between them so you can make the best choice for your situation.
FHA vs. conventional loan
FHA and conventional loans can be used to buy most primary residences but differ in terms of down payment requirements, borrower criteria, and maximum borrowing limits.
|FHA loan||Conventional loan|
|Minimum down payment||3.5%||3%|
|Minimum credit score||500 with a 10% down payment
580 with a 3.5% down payment
|620 or higher|
|Yes||Not if you have a 20% down payment|
|Loan limit||Dependent on location||Up to $548,250 in most of the country for conforming loans|
|Best for...||Borrowers with poor credit or first-time homebuyers||Borrowers with good to excellent credit|
How do FHA loans work?
There are different types of FHA loans, including its 203(b) loan, which acts as a standard home loan. Through the FHA’s 203(b) loan program, qualifying homebuyers can purchase homes with as little as 3.5% down, and they could potentially qualify without perfect credit.
While 203(b) FHA loans are often recommended to first-time buyers on the path to homeownership, they aren’t limited to that group. You might be able to get an FHA loan even if you’ve bought a house in the past.
FHA loans can be used to purchase owner-occupied primary residences, meaning you can’t use them to buy a rental property or second home. You can buy many different types of homes with an FHA loan, including single-family houses, one-to-four-family dwellings, or manufactured homes.
You could even use an FHA loan to refinance an existing mortgage. However, there are maximum borrowing limits that apply to FHA loans that are based on your location.
It’s important to note that all FHA loans require upfront and monthly mortgage insurance premiums (MIPs). The upfront premium equals 1.75% of your base loan amount and is due within 10 days of your closing date. After that, homeowners pay a monthly premium, which totals 0.45-1.05% of the loan amount per year. The amount will vary depending on the loan term, loan amount, and down payment.
Appraisal fees might also be higher with an FHA loan than they could be with a conventional loan. With an FHA loan, the appraisal fee is usually between $400 and $500. For conventional loans, that fee is typically between $300 and $400.
FHA loans aren’t issued directly by the government; instead, you’ll work with an FHA-approved lender to apply for a mortgage.
Who are FHA loans best for?
FHA 203(b) loans could be a good option for homebuyers that have less-than-stellar credit. The credit score requirement for FHA loans is just 500 for those with a 10% down payment, which is lower than the score conventional mortgage lenders generally accept.
There is no minimum income required for FHA loans, but you need a debt-to-income ratio (DTI) of 43% or less.
How do conventional loans work?
Conventional loans are offered by banks, credit unions, and online lenders. These lenders typically look at borrowers’ credit history and income during the loan approval process, and tend to reserve the lowest rates for borrowers with excellent credit.
Conventional mortgage loans can be used to purchase many property types, including single-family homes, vacation homes, and rental properties. You could also refinance a conventional mortgage to take advantage of lower interest rates.
There are two primary types of conventional loans — conforming and non-conforming. Conforming loans fall within the loan servicing limits set by the Federal Housing Finance Agency (FHFA), Freddie Mac, and Fannie Mae. For most of the country, the maximum conforming loan limit is $548,250, but high-cost areas have a maximum of $822,375.
Non-conforming loans are conventional mortgages that don’t fall within those limits. For instance, a jumbo loan is a type of non-conforming loan that typically exceeds those limits.
If you’re wondering how to get a loan, conventional mortgages could require smaller down payments than FHA loans, though this isn’t always the case. Some lenders might approve your application with as little as 3% down, and they could allow a higher DTI. However, loan requirements will vary from lender to lender. Lenders also generally require that borrowers have a credit score of 620 or higher to get a conventional loan.
In general, conventional loans do not require private mortgage insurance if a borrower puts down a 20% down payment.
Who are conventional loans best for?
A conventional loan might make more sense than an FHA loan if you have excellent credit and a sizable down payment. Borrowers with excellent credit might qualify for lower interest rates than they’d get with an FHA loan. If they have a 20% down payment, they could also avoid the cost of mortgage insurance.
7 important differences between FHA vs. conventional loans
FHA mortgages and conventional mortgages differ in several key ways. When deciding which is right for you, keep the following characteristics in mind:
1. Credit score requirements
FHA loans tend to have much lower credit score requirements than conventional mortgages. For an FHA loan, you could potentially qualify for a mortgage with a score as low as 500. However, you’ll likely need a score of 580 or higher to get maximum financing and a 3.5% down payment. By contrast, conventional mortgages typically require a higher credit score of 620 or above, though requirements may vary by lender.
2. Debt-to-income ratio
When you apply for any kind of mortgage, lenders typically review your debt-to-income ratio (DTI). Your DTI is the amount of your monthly debt payments divided by your pre-tax monthly income. For FHA loans, you typically need a DTI of 43% or lower to qualify for a mortgage.
With conventional mortgages, the DTI requirements can vary by lender. However, some lenders might accept borrowers with a DTI as high as 50%.
3. Interest rates
With both FHA loans and conventional loans, you can typically choose between a fixed-rate mortgage and an adjustable-rate mortgage. A fixed-rate mortgage has the same interest rate for the entirety of your loan term, while an adjustable-rate mortgage’s interest rates may fluctuate over time.
In general, FHA loans tend to have lower interest rates than conventional loans. Because the government backs FHA loans, there may be less risk to the lender, and they might offer better rates than conventional loan lenders.
However, borrowers with excellent credit might qualify for conventional mortgages with lower interest rates, so it makes sense to shop around with multiple lenders.
To find out what mortgage rates you might expect to receive, try the Consumer Financial Protection Bureau’s explore interest rates tool. When you enter your credit score, location, and down payment amount, the tool will tell you what rates lenders are currently offering to borrowers for both conventional and FHA loans. Just keep in mind that as you’re using this tool that actual rates may vary by lender.
|Typical interest rate for FHA loans
(as of Aug. 5, 2021)
|Typical interest rate for conventional loans
(as of Aug. 5, 2021)
|For these examples, the borrower had a 620 credit score. The borrower was purchasing a $300,000 home with a 5% down payment and opted for a 30-year fixed-rate mortgage. Rates are current as of Aug. 5, 2021.|
4. Mortgage insurance
Mortgage insurance payments can add to the cost of your loan. Borrowers are required to pay FHA mortgage insurance regardless of their total down payment amount. Premiums are paid both upfront and monthly and generally last for the duration of your mortgage. Your upfront mortgage insurance premium is 1.75% of the base loan amount. Monthly premiums add up to anywhere between 0.45% and 1.05% of your loan amount per year. The amount you’ll pay depends on your loan term, down payment, and total loan.
If you apply for a conventional mortgage, you generally only have to worry about mortgage insurance if your down payment is less than 20% of the home’s price. Private mortgage insurance (PMI) is paid to offset some of the lender’s risk.
5. Home criteria
When shopping for a home, keep in mind that the mortgage type you choose will affect your options.
FHA loans can only be used to purchase properties that meet the U.S. Department of Housing and Urban Development (HUD) standards for properties, which could be more strict than local building codes. With an FHA loan, the home seller is required to correct any safety or soundness issues before closing, or the funds for repairs have to be put into a buyer's escrow account.
If you’re buying a house with a conventional mortgage, the property doesn’t have to meet the same property standards. In-depth inspections aren’t required, though the house will generally have to undergo an appraisal to determine if its value aligns with the sale price. Appraisals are done for the benefit of the lender. Borrowers might also choose to hire a home inspector to assess the home’s condition and potentially negotiate repairs with the seller before closing.
6. House use limitations
FHA loans can only be used to purchase owner-occupied primary residences, including single-family or 1- to 4-unit properties. You can’t use them to finance second homes or investment properties you don’t plan to live in.
Conventional loans don’t limit how a home will be used. You could use a conventional mortgage to buy a primary residence, investment property, or vacation home, but some lenders might require larger down payments for certain types of properties.
7. Maximum purchase price
If you qualify for an FHA loan, there are limits on how much you can spend on a home. The amount you can spend is typically based on the median housing amounts in your area and varies by location.
For example, the FHA loan limit for a single-family home in Kissimmee, Florida, is $356,362, while the most you can spend in San Diego, California, is $753,250. You can find out the limit for your location by using the FHA mortgage limits database.
Certain conventional loans have limits as well, but they’re different from the maximums for FHA loans. For instance, conforming loans fall within certain limits set by the FHFA, Freddie Mac, and Fannie Mae. As of 2021, the limit for conforming loans is $548,250 in most of the country, but high-cost areas have a maximum of $822,375. You can find the current conforming loan limits on the FHFA website.
It is possible to get a conventional mortgage for a higher amount, but you’ll likely have to work with a mortgage lender that offers non-conforming loans — or loans that fall outside those limits.
Which loan product should you choose?
If you’re trying to decide which mortgage type is right for you, several factors could impact your decision. The amount of money you have available for a down payment, your credit score, and your location can all affect your options. If you’re still not sure, consider these examples:
Better mortgage type if you’re in an extremely competitive housing market: Conventional
When the housing market is very competitive, houses may sell within hours of listing, and homes might receive multiple bids over their asking price.
In a competitive market, an FHA loan could be a barrier to closing the deal. Because FHA loans have stringent requirements for the house’s structure and condition, many sellers might prefer not to work with buyers using FHA-backed financing. With a conventional loan, you might skip some of those obstacles.
Better mortgage type if you have a credit score under 620: FHA
Conventional mortgage lenders generally require borrowers to have a credit score of 620 or above. If your credit is lower than that, you could struggle to qualify for a loan, or you might have to pay a high interest rate.
With an FHA loan, you could potentially qualify for a mortgage with a score as low as 500 if you have a 10% down payment.
Better mortgage type if you have a small down payment: Conventional
Saving for a down payment on a home is a big task. If you don’t have a ton of money in savings, choosing a loan type that requires a low down payment amount is important.
If you have good credit and a low DTI, you could potentially qualify for a conventional mortgage. Some lenders might require a minimum down payment as low as 3%, which is slightly lower than the 3.5% down payment required for an FHA loan.
To put those percentages in perspective, consider this example: If you’re purchasing a $300,000 home, you’ll need to have at least $9,000 saved for a conventional mortgage. If you opt for an FHA loan, you’ll need to have at least $10,500. The difference in down payment requirements could be significant if the perfect home popped up and you don’t want to delay to save more money.
Better mortgage type if you want a low interest rate: FHA
FHA loans are government-insured mortgages, and lenders might consider them less risky than conventional loans. Because of the lower risk, FHA loans typically have lower interest rates than conventional loans, particularly with borrowers that don’t have good or excellent credit.
With a lower rate, the savings could be significant. For example, if you purchased a $300,000 home with a 5% down payment, you could potentially qualify for a conventional loan with a 3.875% interest rate and a 30-year term. By the end of your loan, you’ll pay $197,463 in interest charges.
If you chose an FHA loan, you could potentially qualify for a 30-year loan at just 3.250%. Over the life of your loan, you’ll pay $161,522 — a savings of over $35,000.
Which is better, an FHA or a conventional mortgage?
When talking about FHA vs. conventional mortgages, there’s no one type that’s better for everyone. Which is right for you is dependent on your credit score, money available for a down payment, DTI, and location.
In general, FHA loans could be better for borrowers with poor or fair credit because FHA loans have lower credit requirements than conventional loans. Conventional loans might work for borrowers with good to excellent credit or looking for a larger loan amount.
What are the drawbacks to FHA loans?
There are disadvantages to using an FHA loan:
- You’ll generally pay mortgage insurance for the life of the loan
- There are caps on home values based on location
- Sellers might not want to work with you because of FHA property condition restrictions
Whether an FHA loan makes sense for you depends on your financial situation.
Are FHA loan closing costs more than conventional loan closing costs?
In general, closing costs are usually 2% to 6% of the home’s price. FHA closing costs are in line with conventional mortgage closing costs with two main exceptions:
- Appraisal fee: The appraisal fee might be higher for an FHA loan. For conventional loans, the appraisal fee is usually between $300 and $400. With an FHA loan, the appraisal fee is usually between $400 and $500.
- Upfront mortgage premium: With an FHA loan, you have to pay an upfront mortgage insurance premium of 1.75% of the base loan amount. However, some borrowers opt to roll that cost into their mortgage amount, so you might not need to have that extra money available at closing. Whether the cost can be rolled into your loan is one of the important mortgage questions to ask your lender.
What's a good credit score for a conventional loan?
Conventional mortgage lenders generally require borrowers to have a credit score of at least 620, though requirements can vary by lender. However, people with better credit scores might qualify for lower interest rates.
Whether you’re a new first-time homebuyer or looking for a larger house than you have now, FHA loans and conventional mortgages are both worth considering. Which loan is better for you will depend on your budget, down payment, and credit score.
When you’re ready to begin the home buying process, shop around with multiple home loan lenders to get the lowest rates. A good place to start is our picks for the best mortgage lenders.
Disclaimer: All rates and fees are accurate as of Aug. 5, 2021.