Conventional Mortgage vs. FHA

FHA vs. conventional mortgages overview

It's important to understand what each loan type is and how it works. This knowledge will help you determine which option best aligns with your financial situation and homeownership goals.

• Conventional mortgages are home loans offered by private lenders without direct government backing. These loans typically require higher credit scores and larger down payments but can offer more flexible terms and the opportunity to avoid mortgage insurance with a down payment of 20% or more.
• FHA mortgages, on the other hand, are government-backed loans designed to help borrowers with lower credit scores or smaller savings for a down payment. FHA loans are ideal for first-time homebuyers or those who need more lenient qualification requirements, although they require mortgage insurance regardless of the down payment amount.

FHA vs. conventional loan financial requirements

These two popular financing options have some notable differences that will benefit different buyers. For instance, FHA loans often have less rigid credit score requirements. Conventional loans, however, let you skip mortgage insurance if you make a higher down payment.

Credit score

Your credit score plays a major role in determining your eligibility and the interest rates you’ll receive on a mortgage. It reflects your creditworthiness and how reliably you’ve managed debt in the past.

FHA

The credit score requirements for FHA loans are generally less stringent than those for conventional loans. An FHA home loan requires a credit score of at least 580 for a 3.5% down payment.

If you have a credit score between 500 and 579, you need to put down at least 10%, according to FHA loan guidelines. However, keep in mind that your lender may still require a higher credit score (at least 620) to qualify for the loan.

Conventional

Conventional loans generally require a credit score of 620 or more. Even then, your lender may prefer a higher credit score, especially for low-interest financing.

» MORE: What credit score is needed to buy a house?

Down payment amount

A down payment is the upfront cash you pay when buying a home, which helps determine your monthly mortgage payments and whether you’ll need to pay for mortgage insurance.

FHA

FHA loans typically require a minimum down payment of 3.5%, assuming your credit score is at least 580. If your score is below that, you need to put down 10% or more.

Conventional

With a conventional loan, you can sometimes put down as little as 3%, but a higher down payment lets you reduce your monthly payments. A 20% down payment means you can avoid private mortgage insurance (PMI).

Debt-to-income ratio

Your debt-to-income (DTI) ratio helps lenders see how much of your total monthly income needs to go to your debts, such as student or car loans.

The formula for calculating DTI is:

Total monthly debt payments ÷ total monthly income x 100

For example, if each month you pay $1,000 in student loans, $300 on your car loan, and $500 to credit card debt, and you make $4,000 per month, your DTI is:

$1,800 ÷ $4,000 x 100 = 45%

FHA

FHA loans require a 43% to 45% (or lower) DTI, depending on the buyer’s circumstances.

Conventional

Conventional loans often have a maximum DTI ratio limit of 45%, but this doesn’t apply in all situations. Strong borrowers with high credit scores can be approved with a higher DTI ratio than riskier borrowers.

Mortgage insurance

Mortgage insurance is designed to protect lenders in case a borrower defaults on their loan. It is an additional cost that homebuyers may need to factor into their monthly budget.

FHA

“One of the drawbacks of an FHA loan is it does require an upfront mortgage insurance premium known as UFMIP,” said Ron Resha, a Massachusetts-based real estate agent. “However, this upfront-required mortgage insurance can be financed into your loan.”

Along with a one-time insurance payment when you purchase the home, you will also have an ongoing mortgage insurance premium (MIP).

Conventional

With a conventional mortgage, if your down payment is lower than 20%, the lender can require PMI. Factors like your loan amount and credit score influence your total PMI amount.

» MORE: How to get rid of PMI

Conventional vs. FHA: loan limits and property requirements

Along with different financial requirements, FHA loans and conventional loans have different loan limits and property requirements, which can affect how much house you can afford.

Loan limits

Both FHA loans and conventional loans have varying loan limits, depending on your home’s location. The loan limit for FHA loans is significantly lower in most regions, but the amount you’re allowed to borrow also depends on your income and other personal factors.

The loan limits below are for single-family units and are accurate as of the time of publishing:

Both FHA and conventional loan limits change annually. If you need a higher loan than the conforming limit, you can apply for a jumbo loan. This financing option lets you exceed the conforming limits of traditional loans, but it requires a higher down payment. Jumbo loans can provide great rates for large loans, and lenders offer adjustable- and fixed-rate options.

Primary residence requirement

FHA loans are limited to primary residences and come with some clear standards for the condition of the property. A few standards include:

• Undamaged interior and exterior
• Safe and reasonable property access
• A working, permanent heating system
• All relevant utilities
• No loose wires or electrical systems
• No wood-destroying insect infestation

Conventional loans require residences to meet certain safety standards as well, but they vary by lender and can be more flexible.

Is an FHA or conventional loan better?

Both loan types have their own benefits and drawbacks. Depending on your homebuying goals and finances, you might not be able to choose one loan over the other.

For example, if you are buying a second home, rental or vacation home, you will not qualify for an FHA loan. If you have an excellent credit score, a conventional loan might cost you less in the long run with lower interest rates.

Bottom line

Understanding the differences between conventional mortgages and FHA loans can help you choose which is right for your finances and homebuying situation.

FHA loans can be a good option for borrowers with lower credit scores or limited down payment funds, while conventional loans may offer more competitive interest rates and the ability to avoid mortgage insurance if you can make a larger down payment.