Loans are usually a vital element of the home-buying process. Two of the most popular choices are FHA and conventional mortgages. The differences between conventional and FHA loans can affect which you might choose.
FHA, or Federal Housing Administration, loans are issued by private lenders and backed by the U.S. government to help make homeownership more accessible. You can expect lower qualifying credit rates, lower down payments and lower closing costs with FHA loans. However, interest rates may be higher than conventional loans, and you might have to follow home price maximums set by the government.
Conversely, loan associations, banks and credit unions offer conventional loans. Conventional loans are more flexible and are not backed by the government. However, this means that requirements are based on the lender. That said, you should expect stricter qualifications to get this kind of loan.
Key Takeaways
FHA loans are loans offered by private lenders and regulated by the U.S. government to help more borrowers become homeowners. Private institutions like banks or online lenders offer conventional loans, which are not backed by the government.
Lenders consider your credit score, capability to make payments, requirements for the loan and home price maximums.
Weighing these factors before applying for a loan can help you afford the house you want and choose the right loan for your needs.
Key Differences at a Glance
In order to find the right loan for your housing needs, it helps to understand the key differences between conventional and FHA loans.
What Are Conventional Loans?
Conventional home loans are private mortgages not backed by the government. Banks, credit unions and online lenders offer them. Compared to FHA loans, the terms may be more flexible, and rates and underwriting standards might differ significantly based on the lender, the property, the down payment amount and other factors. Many homebuyers in America typically turn to this type of loan first.
Generally, conventional loans require a credit score of at least 620 and minimum down payments of 3%. If your down payment is lower than 20%, you may be required to purchase private mortgage insurance (PMI), which protects the lender if you default on the loan.
What Are FHA Loans?
An FHA loan is backed by the Federal Housing Administration and approved by the U.S. government. Private lenders issue these mortgages, but they are FHA-insured and follow its rules and regulations.
With the help of this backing, banks can offer loans with fewer restrictions than conventional mortgages, such as a 3.5% minimum down payment or a 500 minimum credit score.
The house buyer pays for FHA mortgage insurance. Because the mortgage is protected against default, the lender's risk of suffering losses is greatly diminished. As a result, lenders may be able to approve mortgages for homebuyers with lower down payments.
The discrepancy between the FHA's formal regulations and the actual needs of mortgage lenders can throw some prospective buyers off. The most lenient FHA regulations are listed below:
- A minimum FICO score of 500
- A maximum debt-to-income ratio of 56.9%
- A minimum down payment of 3.5%
FHA loans are usually used to finance the purchase or construction of single-family homes, multi-family homes, condominium units and other housing types.
Comparing Conventional and FHA Loans
- FactorConventional LoansFHA Loans
Minimum Down Payment
The minimum down payment for
conventional loans is usually
3 to 5% for a single-family
primary residence. It may be
higher if you are refinancing,
buying a second home or
buying a multi-unit dwelling.FHA loan down payments are
usually standard at 3.5%, but
can be up to 10% if your
credit rating is lower than
580.Credit Score Requirements
A credit score of 620 to 640
and above can qualify you for
a conventional loan.You should have a minimum
credit score of 500, but at
least 580 to qualify for a 3.5%
down payment.Debt-to-Income Ratio
A debt-to-income ratio below
43% should help you qualify
for a conventional loan,
although some lenders allow
up to 50%.The debt-to-income ratio for
an FHA loan should be below
50%.Interest Rates
The higher your down
payment, the more likely your
interest rate will be more
favorable for a conventional
loan.Lenders with higher FICO
scores may get better interest
rates when applying for an
FHA loan.Loan Limits
Limits can vary by county, but
they can go up to $726,200 in
many areas or up to
$1,089,300 if you live in a
high-cost area.This can change yearly, but
expect a limit of $472,030 in
most markets and a limit of
$1,089,300 in
high-cost-of-living markets in
2023.
Minimum Down Payment
To determine which loan type is best for you, it helps to consider how the mortgage’s down payments work.
The more money you put down, the more likely you are to get the best mortgage rate. The minimum down payment for conventional loans varies depending on the lender, but a 5% down payment can likely get you approved.
Some lenders can offer a conventional loan depending on their standards for borrowers who meet the requirements but put down less than 5%. If your down payment is lower than 20%, you will likely be required to get private mortgage insurance (PMI), which protects the lender if you default.
A 3.5% down payment of the home's purchase price is the required minimum for FHA loans for single-family homes.
Some FHA lenders may require you to put down 10% (or more) if your FICO credit score is lower than 580, with lenders having the final say. FICO credit ratings as low as 500 are acceptable for FHA mortgages, but lenders infrequently grant loans to borrowers with such low scores.
Credit Score Requirements
One of the easiest ways a lender can determine whether you can afford a loan is by looking at your credit score.
Most lenders would approve a conventional loan application for a borrower with a credit score of 620 and above. The best mortgage rates may not be available at the lower end of the scale. Working for a score of at least 740 can open the door for better terms — but lenders will still consider other aspects of your financial history.
Credit score is not the only factor lenders consider. A higher down payment for a conventional loan or a higher income may help lenders look at you favorably even if your credit score is not in the excellent range.
FHA lenders generally offer the best rates to applicants with higher FICO credit scores.
The standard FHA minimum credit score is 500. At 580 or higher, you may expect better payment options, like a 3.5% down payment. If you have a low credit score, you may be required to come up with a 10% down payment.
Don't be surprised if some lenders require a score of 620 or 680 at the very least. Lenders ultimately decide on requirements, so it can be beneficial for you to compare lenders to find your best options.
Debt-to-Income Ratio
Another factor lenders pay attention to is your debt-to-income ratio. DTI is how much debt you have compared to your income. Generally, the lower your DTI, the better your offers.
DTI requirements for conventional home loans are often lower than 49%, as the preferred DTI ceiling is between 36% and 45% according to Fannie Mae rules. However, underwriting standards for conventional loans may allow for a DTI as high as 50% in some situations, such as when borrowers have a sizable cash reserve, a good credit score or debts that will be paid within months.
Some lenders may use something known as the 28/36 qualifying ratio. In this scenario, a borrower’s DTI should be at most 28% before the mortgage is approved and no more than 36% after the mortgage payment is calculated.
Your total fixed expenses should not exceed 43% of your gross monthly income, according to the FHA's general rule of thumb.
If you have compensating factors, such as a high credit score or the ability to make a sizable down payment, you may be able to go above the FHA's 31/43 guideline. Expect to be subjected to more intense underwriting scrutiny if your DTI is higher than 43% or your credit score is lower than 620.
Interest Rates and Loan Limits
There are different interest rates and loan limits you should be aware of when searching for the best kind of loan for your needs.
A typical conventional loan has a minimum credit score requirement of 620 and a 30-year duration. Down payments for conventional loans can be as low as 3%. Government-backed programs are generous: FHA loans permit credit scores as low as 500, while VA and USDA loans don't require any down payment.
Conforming loans have the following limit ranges in the U.S.:
- 1-unit homes: $726,200–$1,089,300
- 2-unit homes: $929,850–$1,394,775
- 3-unit homes: $1,123,900–$1,685,850
- 4-unit homes: $1,396,800–$2,095,200
The FHA's loan limits for the majority of single-family houses range from $472,030 to $1,089,300 in 2023, depending on location. The ceiling in highest-cost areas is $1,633,950, while the limit for most counties is less. The loan limit for one-unit dwellings rose by over $51,000 for 2023 compared to 2022, and limits are based on median home prices in a given county.
Loan ceilings differ in “special exception” higher-cost areas like Alaska, Guam, Hawaii and the U.S. Virgin Islands. Depending on the county, the limit for a single-family home in the highest-cost areas can be up to $1,633,950.
Mortgage Insurance
Mortgage insurance might be something you'll face when applying for either a conventional loan or an FHA loan. It helps to check before making a decision.
With a conventional loan, there's a strong possibility your lender will require PMI if your down payment is less than 20%. Fortunately, there are various ways to avoid PMI even with a smaller down payment. But in general, you can expect to have PMI added to your monthly payment if you aren't putting 20% down.
The good news is that the PMI may eventually be eliminated once your home reaches a specific valuation in relation to your mortgage balance.
Mortgage insurance for FHA loans is mostly mandatory. However, you don't have to pay the full amount once a year. The annual premium, divided by 12, is added to your monthly mortgage payment. When your loan is approved, an upfront premium needs to be paid and added to your loan amount. The current standard is 1.75% of your loan amount.
Consult a mortgage professional for your FHA loan quote so you understand what you need to pay.
Which One Is Right for You?
Want to know which loan is worth it for your circumstances? Weigh all the pros and cons of FHA loans vs. conventional loans before deciding on what's best for you.
A Conventional Loan is Worth It If…
When a conventional loan is beneficial:
- Your credit score is above 740 and you qualify for better terms.
- You can skip PMI entirely with a down payment of at least 20%.
- You don't have to think about home price maximums when applying for a conventional loan.
- You need to borrow more money than you can with an FHA loan.
- You want lower interest rates.
- You want to negotiate with your lender for more flexible terms.
An FHA Loan Is Worth It If…
When an FHA loan is beneficial:
- You have a lower credit score, typically at least 580.
- You need to pay a lower down payment or ask your lender if they have an assistance program to help you pay the down payment.
- You can qualify for much lower DTI requirements.
- You don’t want to worry about income requirements.
- You want more lenient requirements from your lender when applying.
Frequently Asked Questions About Conventional and FHA Loans
Still got questions? Familiarize yourself with the following answers to these FAQs before applying for either a conventional or FHA loan.
sources
- U.S. Department of Housing and Urban Development. "Maximum Mortgage Limits 2023." Accessed December 12, 2022.