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If you’re getting ready to buy a house, you have a lot of decisions to make. The same way that you can explore property options, you can (and should) explore different mortgage options. The two most popular types of mortgages are conventional loans and FHA loans. Here, we’ll help you decide which might be better for your needs and situation.
What is an FHA loan?
FHA loans are backed by the Federal Housing Administration (FHA), meaning the FHA protects lenders it approves against loss if a borrower stops paying their mortgage. FHA loans are geared toward homebuyers who might have difficulty obtaining conventional financing (more on that below), primarily by having a lower minimum credit score requirement and other flexible qualification criteria.
What is a conventional loan?
Conventional loans are mortgages that aren’t backed by the government. They are available through the majority of mortgage lenders in the U.S. — including banks, credit unions and online lenders — and can come in a range of terms, commonly 15 or 30 years, with a fixed or adjustable interest rate.
Depending on the characteristics of the loan, a conventional mortgage is either conforming or nonconforming. Often, conventional lenders sell these types of mortgages to Fannie Mae or Freddie Mac after they’re funded. In order to do this, the loan has to conform to, or meet, Fannie and Freddie standards around credit score, loan size and other factors. If it doesn’t, the mortgage is considered nonconforming.
FHA vs conventional loans: What’s the difference?
| FHA loans | Conventional loans | |
|---|---|---|
| Credit score minimum | 580 (with 3.5% down) or 500 (with 10% down) | 620 |
| Debt-to-income (DTI) maximum | 50% | 43% |
| Down payment minimum | 3.5% (with a 580 credit score) or 10% (with a 500 credit score) | 3% for fixed-rate loans or 5% for adjustable-rate loans |
| Loan limits | $472,030 in most areas | $726,200 in most areas |
| Mortgage insurance | Mortgage insurance premiums (MIP) required on loans with less than 20% down; unremovable | Private mortgage insurance (PMI) required on loans with less than 20% down; removable |
| Interest rates | FHA loan rates | Conventional loan rates |
Difference in credit score requirements
FHA loan borrowers can qualify with a credit score as low as 500 or 580 depending on their down payment amount: as low as 500 with 10 percent down, or as low as 580 with 3.5 percent down. Conventional loans require a credit score of at least 620. If you have excellent or good credit, a conventional loan is often the better choice.
Difference in DTI ratio requirements
Another FHA vs. conventional loan differentiator: the debt-to-income (DTI) ratio maximum. This ratio is the measure of all your debt (the mortgage included) relative to your monthly income. For a conforming conventional loan, the maximum DTI ratio is 43 percent. For an FHA loan, the DTI ratio can go up to 50 percent.
Difference in down payment requirements
Depending on the lender and program, some conventional loans require as little as 3 percent or 5 percent for a down payment. If your credit score is at least 580, you can put down just 3.5 percent for an FHA loan; if your score is below 580 (but not lower than 500), you’ll be required to put down 10 percent. Here’s more on minimum down payment requirements.
For either loan, if you put down less than 20 percent, you’ll be required to pay for mortgage insurance.
Difference in loan limits
Depending on your location, choosing between an FHA versus conventional loan might come down to the price of the house you want to buy.
Both types of loans have limits on the amount you can borrow. The conventional conforming loan limit, set by the Federal Housing Finance Agency each year, starts at $726,200 this year and goes up to $1,089,300 in more costly housing markets. A conventional loan can exceed these limits, but at that point, it’d be considered a nonconforming jumbo loan.
The FHA loan limit is also adjusted each year, and there are different limits based on location and property type. In 2023, the FHA loan limit for a single-family home is $472,030 in most markets and goes up to $1,089,300 in higher-cost areas.
Difference in mortgage insurance requirements
If you don’t have 20 percent of the home’s purchase price for a down payment, you’ll be required to pay for mortgage insurance whether you’re getting a conventional or FHA loan. Both premiums are typically paid via your monthly mortgage payment.
FHA mortgage insurance includes an upfront premium equal to 1.75 percent of the amount you’re borrowing. Then, you’ll pay an annual premium, which is determined by the size of your down payment, how much you borrowed and the length of the loan (15 years versus 30 years).
Aside from differences in premium structure, conventional loan borrowers don’t have to pay for mortgage insurance forever — it can be canceled once there’s 20 percent equity in the home. You can do this simply by following your repayment schedule to pay down the loan balance, making extra payments, or refinancing or getting a new appraisal if your home’s value has risen substantially.
In contrast, FHA mortgage insurance can’t be canceled unless you put at least 10 percent down (if so, it’ll be canceled after 11 years), or you refinance to a different type of loan.
Difference in interest rates
While your interest rate is primarily determined by your credit score, the type of loan can also be a factor. FHA loans sometimes have more favorable interest rates, but the annual percentage rate (APR), which encompasses the interest rate plus fees, might be higher. Compare FHA versus conventional loan rates (including APRs) from a few different lenders to ensure you’re getting the lowest one possible.
How to choose between an FHA loan or a conventional loan
Which loan is better: FHA or conventional? To a large extent, that depends on you. If your credit score is below 620, a loan backed by the FHA might be your only option. Generally, a conventional loan is best for those with strong credit and a bigger homebuying budget. Ultimately, the decision comes down to the type of home you want and your financial situation.
