Article

FHA vs. Conventional Loans

FHA loans allow lower credit scores than conventional mortgages do, and are easier to qualify for. Conventional loans allow slightly lower down payments.

Hal M. Bundrick, CFPAugust 15, 2019

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Let’s see, FHA loans are for first-time home buyers and conventional mortgages are for more established buyers — right?

Not necessarily.

FHA loans are insured by the Federal Housing Administration, and conventional mortgages aren't insured by a federal agency. Both types of loans have their advantages for any type of buyer, but qualification requirements differ. Here are the factors to weigh when considering an FHA loan vs. a conventional loan.

How to compare FHA vs. conventional loans

Ending the FHA versus conventional debate starts with a discussion of your down payment funds and credit score. The two loans differ greatly when it comes to minimum requirements in these areas.

Minimum down payment

FHA loans have a minimum down payment of 3.5% for borrowers with credit scores of 580 or higher. Some conventional mortgages allow a 3% minimum down payment, but it’s reserved for borrowers with credit scores in the high 600s and ample savings.

Credit scores

FHA loans are easier to qualify for, with a minimum credit score of 580 to be eligible to make a 3.5% down payment. If your credit score is 500 to 579, you may qualify for an FHA loan with a 10% down payment.

Conventional loans typically require a credit score of 620 or higher, says Joe Parsons, a senior loan officer with PFS Funding in Dublin, California. He adds that a lower credit score often comes with a higher interest rate for a conventional loan.

Debt-to-income ratios

Your debt-to-income ratio, or DTI, is the percentage of your monthly pretax income that you spend to pay your debts, including your mortgage, student loans, auto loans, child support and minimum credit card payments. The higher your DTI, the more likely you are to struggle with paying your bills.

Your debt-to-income ratio must be 50% or less to qualify for an FHA loan. Conventional loans allow debt-to-income ratios up to 50% in some cases, too. Even though lenders allow debt-to-income ratios that high, approval is more likely for mortgage borrowers with DTIs of 43% or less.

Mortgage insurance

Mortgage insurance protects the lender in case of default. Conventional loans require borrowers to pay for mortgage insurance if their down payment is less than 20%. FHA loans require mortgage insurance regardless of down payment amount. Other differences are:

  • FHA mortgage insurance premiums cost the same no matter your credit score. Private mortgage insurance on conventional loans costs more if you have a low credit score, but it may cost less than FHA mortgage insurance if your credit score is above 720.

  • FHA mortgage insurance premiums last for the life of the loan if you make a down payment of less than 10%. You can get rid of FHA mortgage insurance by refinancing to a conventional loan. By contrast, private mortgage insurance is automatically canceled on conventional loans after your equity reaches 78% of the purchase price.

  • Both FHA and private mortgage insurance costs vary according to the size of the down payment.

Loan limits

Both conventional and FHA loans limit the amount you can borrow, and the maximum loan sizes vary by county. Regulators may change the loan limits annually.

The 2019 FHA loan limit is $314,827 in low-cost areas and $726,525 in expensive markets. Conventional loans are subject to the conforming loan limit set by the Federal Housing Finance Agency. In 2019, that limit is $484,350 for most of the U.S. Non-government mortgages that exceed that threshold are called “jumbo loans.”

Property standards

The property’s condition and intended use are important factors when comparing FHA vs. conventional loans.

FHA appraisals are more stringent than conventional appraisals. Not only is the property assessed for value, but it is also thoroughly vetted for safety, soundness of construction and adherence to local code restrictions.

When you get an FHA loan, you have to live in the house as your primary home. Investment properties and homes that are being flipped (sold within 90 days of a prior sale) aren’t eligible for FHA loans.

You can use a conventional loan to buy a vacation home or an investment property, as well as a primary residence.

Refinancing

As far as mortgage refinancing goes, the edge goes to FHA “streamline” refinancing. With no credit check, no income verification and likely no home appraisal, it’s about as easy a refi as you can get. But there are five strict requirements for an FHA streamline refinance.

There's another reason to refinance an FHA loan: to get rid of the monthly mortgage insurance payments. FHA mortgage insurance can't be canceled if you made a down payment of less than 10%. To get rid of the monthly FHA premiums after you have accumulated 20% equity, you have to refinance into a conventional mortgage.

FHA vs. conventional loans: Summary

FHA and conventional mortgages have a few key differences:

Conventional loans

  • Require higher credit scores.

  • Allow slightly smaller down payments.

  • Have more liberal property standards.

  • Require private mortgage insurance when the down payment is less than 20%, and it may be canceled.

FHA loans

  • Allow lower credit scores.

  • Require slightly higher down payments.

  • Have stricter property standards.

  • Make FHA mortgage insurance mandatory regardless of the down payment amount, and it can’t be canceled unless you refinance into a conventional loan.

Borrowers with credit scores below 620 don't qualify for conventional mortgages, so FHA is the most likely option for them. Borrowers with credit scores of 720 or higher will usually find that conventional loans cost less per month. And borrowers with credit scores lower than 720 will usually find that FHA loans cost less per month.

A mortgage loan officer can help you compare FHA vs. conventional loans and answer questions about their differences.

One other thing: If you are serving in the military or are a veteran, a loan backed by the VA may be the way to go. VA loans usually require no down payment. And if you live in a suburban or rural area, a USDA loan could be a smart option, too.