FHA Vs. Conventional Loan: What’s The Difference And Which Is Right For You?

Embarking on the exciting journey of buying a house opens up a world of opportunities, and understanding the differences between FHA and conventional loans can empower you to make the right choice.

You may have read that FHA loans are geared toward first-time home buyers who need a low down payment option. Perhaps you’ve also heard that conventional loans are tailor-made for more experienced buyers – or at least buyers who have good credit and well-established finances.

The reality is that conventional loans and FHA loans are two of the most popular types of mortgages because of their versatility and ability to meet buyers at various levels of qualification.

What Is An FHA Loan?

An FHA loan is a type of mortgage backed by the Federal Housing Administration (FHA), a part of the U.S. Department of Housing and Urban Development (HUD). This means the government will help protect the lender’s investment against default, which can make qualifying easier.

As a government-backed loan, an FHA loan – also known as a 203(b) loan – can afford to be more lenient with some borrowing requirements. This means there are lower credit score and down payment requirements compared to other loans. Because of this, FHA loans are a popular option among first-time home buyers and those with low-to-moderate incomes.

What Is A Conventional Loan?

A conventional loan is a mortgage offered through a private lender, used to finance the purchase of a new home or to refinance an existing mortgage. Unlike an FHA loan, these loans are not government-supported, leading to stricter eligibility requirements.

When you apply for a conventional loan, you'll need to meet certain requirements related to your down payment, credit score and debt-to-income ratio (DTI). Although these specific requirements may vary among different lenders, the process for applying and gaining approval for these loans is generally similar across the board.

Differences Between FHA Loans And Conventional Loans

The following table provides a clear and concise comparison between FHA and conventional loans, illustrating the key differences in essential factors that potential home buyers need to consider.

FHA Vs. Conventional Loan: Credit Score And Down Payment

Regardless of the loan type, your mortgage lender will assess your credit score during the underwriting process, which helps determine your expected down payment. Your down payment is a percentage of the purchase price paid upfront.

You can typically qualify with most FHA lenders – including Rocket Mortgage – with a 580 credit score or above. A credit score of 580 or higher may allow a 3.5% down payment. Some lenders may accept a score as low as 500, but you’ll typically need at least a 10% down payment.

Conventional Loan

Because conventional loans aren’t backed by a government agency, you’ll need a higher credit score to qualify for a conventional mortgage, generally a 620 score or higher. A minimum down payment of 3% is possible on a conventional loan, but 20% or more is needed to avoid PMI.

FHA Vs. Conventional Loan: DTI

Your debt-to-income ratio (DTI) is the percentage of your monthly gross (pretax) income that goes toward paying off debts such as a mortgage, rent, auto loans, student loans or credit cards. The lower your DTI, the less likely you are to miss your mortgage payments.

FHA Loan DTI

Your monthly mortgage payments on an FHA loan should be lower than 31% of your monthly gross income, which is why you should generally have a DTI of 43% or lower to qualify for an FHA loan. However, if you have an excellent credit score, your lender may approve you with a DTI as high as 50%.

Conventional Loan DTI

While you can qualify for a conventional loan with a DTI of 50% or lower, most lenders prefer you to have a DTI of 36% or lower, and they’ll often require a higher mortgage interest rate if your DTI lands between 37% and 50%.

FHA Vs. Conventional Loan: Mortgage Insurance

Mortgage insurance protects the lender in case you default on your loan. Mortgage insurance on FHA loans is called a mortgage insurance premium – or MIP – while conventional loans require private mortgage insurance (PMI) for some borrowers.

FHA MIP

Because of the lower credit score requirements for FHA loans, MIP is mandatory, regardless of the down payment size.

MIP has two main components:

• Upfront Mortgage Insurance Premium: This is equal to 1.75% of the total loan amount and paid at closing or can be rolled into the overall loan amount.
• Monthly Mortgage Insurance Premium: This cost is included in your monthly mortgage payments.

If you make a down payment of 10% or more, the MIP will only apply for the first 11 years of the loan. If the down payment is less than 10%, the MIP will apply for the entire loan term. Therefore, with an FHA loan, you're required to pay an upfront percentage during closing and continue to pay mortgage insurance monthly.

Conventional Loan PMI

Unlike FHA loans, conventional loans only require PMI if you make a down payment of less than 20% of your home’s value.

Another key difference is that you won’t have to pay PMI over the entire life of the loan. Once you reach 20% equity in your home, you can request that your lender remove PMI from your monthly payments. At 22% equity, your lender must automatically eliminate PMI from your mortgage payments.

FHA Vs. Conventional Loan: Mortgage Rates

One way that lenders manage risk is through mortgage interest rates. Some factors that influence mortgage rates are out of your control, such as housing market conditions, inflation and the Federal Reserve. However, your loan amount, down payment and credit score can have a significant effect on your rate.

FHA Mortgage Rates

On average, FHA loans offer lower mortgage interest rates than conventional loans. However, if you have a high DTI or a low credit score – or you have to make a low down payment – your lender may increase your mortgage rate to offset that risk.

Conventional Mortgage Rates

In addition to your credit score, loan amount, down payment and other factors, mortgage lenders will determine your mortgage rate based on whether you apply for an adjustable-rate mortgage (ARM) or a fixed-rate mortgage.

While conventional loan rates are generally higher than what FHA loans offer, an excellent credit score, a high down payment or a DTI of no higher than 36% could get you a lower mortgage rate on a 15-year fixed-rate home loan.

FHA Vs. Conventional Loan: Loan Limits

Both FHA and conventional mortgages set loan limits that cap the amount you can borrow to buy a home. The loan limit for either mortgage product varies depending on where you’re looking to purchase.

FHA Loan Limits

In most areas in 2023, you can borrow up to $726,200 on a one-unit property. This loan limit increases to $1,089,300 in high-cost counties within the U.S.

You can find the maximum loan limit in the area where you intend to purchase by visiting the FHA Mortgage Limits page of the HUD website.

Conventional Loan Limits

Conventional mortgages offer similar loan limits as FHA loans in comparable areas. For example, in 2023 you can borrow up to $726,200 for a single-family home or property in most U.S. counties.

In high-cost areas – such as Alaska and Hawaii – the loan limit increases to $1,089,300.

For properties that exceed the loan limits in a particular area, you’ll need to consider financing with a jumbo loan. Jumbo loans are conventional loans that don’t conform to Fannie Mae or Freddie Mac guidelines, so they’re considered nonconforming loans and come with stricter underwriting guidelines because of the increased risk they present to lenders.

FHA Vs. Conventional Loan: Property Standards

In general, FHA loans have stricter property standards and occupancy requirements governing the property’s overall safety.

FHA Loan Property Requirements

Similar to VA loans, the property you finance with an FHA loan must serve as your primary residence, so you won’t be able to purchase an investment property or vacation home. Under most conditions, you also have to occupy the property within 60 days of closing.

FHA loans must also abide by stringent property standards. In addition to property value, FHA appraisals thoroughly evaluate the home’s structural integrity, adherence to building codes and overall safety.

Conventional Loan Property Requirements

Unlike FHA and other government-backed mortgages, conventional loans don’t have strict property or occupancy restrictions. In addition to financing a primary residence, you can use a conventional mortgage to purchase a second home or vacation home – as well as a rental home or other investment property.

FHA Vs. Conventional Loan: Refinancing

FHA refinancing often comes with a quicker turnaround time, making it appealing for those looking to refinance promptly. Various options are available, all of which require an MIP.

On the other hand, conventional loan refinancing offers a lot of variety, catering to different needs and preferences. Although it may not have the same rapid processing as FHA refinancing, it provides flexibility in terms and does not require PMI if you have at least 20% equity.

Conventional Vs. FHA Loan Pros And Cons

Navigating the mortgage landscape requires understanding the nuances of different loan types, especially when weighing the pros and cons of conventional and FHA loans. The right choice often depends on your unique financial situation.

Conventional Loan Pros And Cons

FHA Loan Pros And Cons

FHA Vs. Conventional Loan FAQs

Learn more about FHA and conventional home loans with the answers to these commonly asked questions.

Is it better to use an FHA loan or a conventional loan?

Choosing between an FHA loan or a conventional loan depends on individual circumstances. For first-time home buyers or those with lower credit scores and minimal down payment, an FHA loan might be more accessible due to its lower eligibility requirements.

Conventional loans may be more appealing to those with good credit and established finances, offering potentially lower interest rates and no required mortgage insurance with a down payment of 20% or more.

When should I get an FHA loan over a conventional loan?

An FHA loan may be a more suitable option over a conventional loan if your credit score is lower than 620 or your DTI is high. These factors make FHA loans more accessible, especially for first-time home buyers or those who may not qualify for conventional financing.

Do sellers prefer a conventional loan over an FHA loan?

Yes, sellers often prefer a conventional loan over an FHA loan. This preference stems from the perception that conventional loans may have a smoother and quicker closing process, without the stringent property standards required by FHA appraisals. FHA loans often require sellers to make additional repairs to meet the guidelines, which can lead to delays or additional costs in the home buying process.

The Bottom Line

With government-backed loans like the FHA loan program, you’ll likely find more relaxed qualifications and, as a result, more accessible financing options.

While you may face stricter loan requirements – such as a lower DTI and a higher credit score – to qualify for a conventional loan, you can eventually eliminate PMI and potentially save more money over the life of your loan.

Need more help deciding which loan is right for your home buying needs? Start the application today with our sister company Rocket Mortgage and speak with a Home Loan Expert to see what you qualify for.