FHA vs. Conventional Loans: What Are the Differences?

Written by Kim PinnelliUpdated: 28th Dec 2021
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FHA loans are known as a first-time homebuyer’s loan, but that’s not the case today. Millions of borrowers use FHA financing to buy their homes, but a conventional loan can be a good option too.

How do you decide which option is right for you? Check out our guide on FHA vs. conventional loans below.

FHA vs. Conventional Loans Overview

There aren’t large differences between FHA and conventional loans, but minor factors can make a big difference in how you qualify for either mortgage.

Conventional loans are for borrowers with good credit buying any type of home – primary residence, second home, or an investment home.

FHA loans are good for borrowers trying to buy a primary residence only but who may have some credit or financial struggles.

Understanding FHA Loans

FHA loans are government-backed loans with flexible underwriting guidelines and competitive interest rates.

They are great for borrowers with less-than-perfect credit, low down payments, or a high debt-to-income ratio.

Understanding Conventional Loans

Conventional loans aren’t government-backed loans. Lenders set their own guidelines, but most follow Fannie Mae and Freddie Mac rules, so Fannie Mae or Freddie Mac buy the loans.

Conventional loans require good credit scores, low debt-to-income ratios but also allow low down payments.

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What Are the Differences Between FHA and Conventional Loans?

Different Down Payments

  • FHA: FHA loans require just 3.5% down if you have at least a 580-credit score. Some lenders also allow credit scores between 500 – 579 with a 10% down payment.
  • Conventional: Conventional loans require 3% down for first-time homebuyers and 5% down for subsequent homebuyers.

Credit Score Requirements

  • FHA: FHA loans require just a 580-credit score. This is much lower than most other loan programs allow today. Like I said earlier, you may even get approved with a credit score between 500 – 579, but this varies by lender.
  • Conventional: Conventional lenders require higher credit scores, usually at least a 640, but sometimes higher. The better your credit score is, the more likely you are to get approved.

Total Loan Limit

  • FHA: FHA loan limits vary by county, but in most low-cost areas, it’s $356,352, and in high-cost areas, $822,375.
  • Conventional: Conventional loan limits are the same across the country except in high-cost areas. In most areas, the limit is $548,250, but in some high-cost areas, it’s as high as $822,375.

Mortgage Insurance

  • FHA: FHA loans require mortgage insurance for the life of the loan. You’ll pay mortgage insurance upfront equal to 1.75% of the loan amount and also annually at 0.85% of the loan amount. You’ll pay the annual amount monthly (1/12th each month), and the amount decreases as you pay your principal balance down.
  • Conventional: Conventional loans only charge mortgage insurance if you put down less than 20% on the home. Once you owe less than 80% of the home’s value, you can cancel it. The amount you’ll pay for private mortgage insurance varies based on your credit score and the loan-to-value ratio. The higher your credit score and the lower your LTV, the less you’ll pay.

FHA vs. Conventional Loans: Which Has Better Interest Rates?

The interest rate is the number one concern of most borrowers, but who has a better interest rate – FHA or conventional loans?

First, you should know that you can’t control market interest rates. Mortgage rates fluctuate daily and sometimes several times a day. They’re dependent on many factors, including the state of the economy and investor demand.

FHA Loan Interest Rates

FHA loan interest rates are competitive. They are sometimes slightly higher than conventional rates, but your rate depends on your qualifying factors.

A good credit score, low debt-to-income ratio, and high down payment will secure you the best FHA loan interest rates, but even a borrower with a low credit score or high debt ratio can still get competitive rates.

Conventional Loan Interest Rates

Conventional rates usually beat FHA loan interest rates by a small amount. Like FHA loans, your rate depends on your qualifying factors. The more positive factors you present, the lower the interest rate you’ll get.

It’s always best to shop around to find the best interest rate. Getting at least three quotes should help you secure the right rate.

When Should You Consider a Conventional Loan?

If you have good credit and can put down 3% – 5% on a loan, I’d suggest a conventional loan. Yes, you’ll pay mortgage insurance on the loan, but it won’t last forever. You can cancel it as soon as you owe less than 80% of the home’s value.

Conventional loans have competitive interest rates and great terms. If you’re buying anything but a primary residence, a conventional loan may be your only option, so work on your qualifying factors to make sure it’s a good fit.

When Should You Consider an FHA Loan?

If you’re a first-time homebuyer or a subsequent homebuyer with a low credit score or you’re having trouble establishing credit, an FHA loan can be a great start.

FHA loans’ more flexible guidelines make it easier to get approved. Because of the more relaxed guidelines, though, you’ll pay for it in mortgage insurance both upfront and monthly. The mortgage insurance lasts for the life of the loan.

I suggest starting with an FHA loan but working on improving your qualifying factors so you can refinance into a conventional loan when you owe less than 80% of the home’s value.

Are FHA or Conventional Loans Better?

Both FHA and conventional loans are great options. You can get competitive interest rates, low fees, and understandable terms.

The mortgage insurance FHA loans charge isn’t a pleasant thought, but if it’s what helps you get the financing you need, then it’s not as bad as it sounds.

The amount you pay decreases each year as you pay the principal balance down, so it’s not a large cost of the life of the loan.

If you qualify for a conventional loan, it’s the obvious choice, but FHA loans aren’t a bad alternative.

Bottom Line: FHA vs. Conventional Loans

Talk to a few lenders and see what your qualifying factors may get you. Some borrowers are surprised to learn they qualify for a conventional loan. Sometimes compensating factors make up for a lower credit score or high debt-to-income ratio.

Get quotes from several lenders to see what options you have available. Compare the total cost of the loan to see which option is right for you.

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Kim Pinnelli
Kim Pinnelli

Kim Pinnelli is a Senior Writer, Editor, & Product Analyst with a Bachelor’s Degree in Finance from the University of Illinois at Chicago. She has been a professional financial writer for over 15 years, and has appeared in a myriad of industry leading financial media outlets. Leveraging her personal experience, Kim is committed to helping people take charge of their personal finances and make simple financial decisions.