FHA vs. Conventional Loan: What’s The Difference?

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There are a few different mortgage programs to choose from, and each one has its own benefits as well as downsides, depending on your financial situation. The two most popular mortgage programs for first-time homebuyers are the FHA and conventional mortgage. 

Let’s cover the differences between FHA and conventional loans to decide which one is right for you.

What Is an FHA Loan?

To help those with low to moderate income purchase a home, the Federal Housing Administration (FHA) oversees and backs loans given to those in this income bracket through its FHA loan program. It’s still issued by a bank, but the Federal Housing Administration ensures that these loans are guaranteed, removing much of the financial burden and risk from the lending institution. 

This type of loan is popular with first-time homebuyers and can be much easier to qualify for than conventional or other types of loans.

What Is a Conventional Loan?

Unlike FHA or VA loans, conventional mortgages aren’t backed or guaranteed by the federal government or any other agency. To qualify for a conventional loan, borrowers need to meet more stringent requirements, such as lower debt-to-income ratios, higher down payments, and other terms and conditions of the loan. With this type of loan, you may be able to avoid paying mortgage insurance premiums (MIP). 

Some sellers prefer conventional loans from buyers, and your offer could look more appealing if you opt for this type of mortgage and meet the requirements.

FHA vs. Conventional Loan: Credit Score Requirements

When comparing FHA loan requirements to conventional loan requirements, you have to consider your credit score. Because an FHA loan is aimed at those in a lower income bracket, the minimum credit score requirement is also lower than that for a conventional loan. 

Here’s a breakdown of the credit score you need to qualify for each of the mortgage types:

FHA loan credit requirements

For an FHA loan, a borrower can have a lower credit score—even in the “very bad” credit score range—and still qualify. You can have a credit score as low as 500 and still get an FHA loan. However, to also get the low down payment percentage rate, you’ll want to aim for a higher credit score in the 580 range.

Conventional loan credit requirements

Although you’ll need better credit to qualify for a conventional home loan, the minimum credit score required will depend on the lender. As a general rule, conventional mortgages often require higher credit scores of at least 620, which would put you in the “fair” range. 

Keep in mind that the better your credit score, the easier it is to qualify for a conventional mortgage loan and the better your interest rate will be.

FHA vs. Conventional Loan: Down Payment Requirements

Like your credit score, the down payment you need will vary depending on the lender, the type of loan you’re applying for, and the loan amount. The loan-to-value ratio of the property, which measures the value of the property compared to the amount of your loan, will be affected by your down payment. Typically, the larger the down payment you make, the less you have to borrow and the less interest you have to pay over the life of the loan. 

Here are the most common down payments for FHA and conventional loans:

FHA loan down payments

Since an FHA loan is intended to make it easier for low-income and first-time homebuyers to get into the housing market, the down payment requirement is much lower. Your down payment amount will depend on your credit score and the lender, but for an FHA loan, the minimum down payment amount can be as low as 3% of the house’s purchase price. 

The standard rate usually falls in the 3.5% range. However, if you have a low credit score that falls between 500 and 579, you might have to put down as much as 10%.

Conventional loan down payments

Many conventional loans require a 20% down payment. If you put down less than 20%, the bank will require mortgage insurance. Private mortgage insurance (PMI) is required when you put down less than 20% because the lender is covering a higher percentage of the home price. 

While the PMI is wrapped up in your mortgage payments, you’ll be paying interest on the mortgage insurance premium and the amount you borrow to purchase the home. 

Those who have owned a home within the last three years will need a minimum down payment of 5%, but conventional loans can offer some buyers a down payment rate of as low as 3%.

 There are many things that go into calculating the amount you want to put down on a new home purchase, and going with the lowest down payment possible isn’t always the best move.

FHA vs. Conventional Loan: Interest Rates

This visual graph compares the FHA vs. conventional mortgage down payment and interest rates for a potential homebuyer. The details will help you compare the differences between the two loan types. 

Take a look at the short-term and long-term differences.

Now let’s break it down a little further to get a better understanding of what these charts mean for your interest rates:

FHA loan interest rates

Here are the details of the FHA loan limits in the graphs:

• Purchase price: $200,000
• Down payment: 3.5% (the minimum down payment for the FHA program)
• Fixed interest rate: 3.75%
• Term: 30 years

You can see that while FHA loans require only a lower down payment of 3.5%, you’ll end up paying more in interest over the life of the loan. Your interest rates will vary depending on the lender and the current rate at the time you borrow, but regardless, you’ll always pay more in interest if you make a smaller down payment.

Conventional loan interest rates

Here’s a look at the details of the numbers in the graph for a conventional mortgage:

• Purchase price: $200,000
• Down payment: 5% (although 20% is preferred, 5% is common)
• Fixed interest rate: 3.75%
• Term: 30 years

The numbers here are almost identical to those for an FHA loan, with the only difference being the down payment amount. However, you can see that even this small detail can make a significant difference in the interest you’ll pay over the life of your home loan. 

Additionally, because you won’t necessarily need to have mortgage insurance, you can save even more on interest in your monthly mortgage payments when you have a conventional loan.

FHA vs. Conventional Loan: Loan Limits

Loan limits regulate the loan amount you can borrow. These limits vary based on the mortgage type and the housing cost in the area where you’re buying a home. 

Conventional loans have higher “floors” and “ceilings” than FHA loans, but both loan types are based on the average home price in the area. The “floor” of the loan is the least amount you can borrow, while the “ceiling” is the maximum amount for the type of mortgage you want. 

Here are the loan limits for FHA and conventional loans:

FHA loan limits

As of 2023, the floor for an FHA loan is $472,030, a difference of more than $50,000 over 2022. The ceiling FHA loan limit is $1,089,300, whereas it previously sat at $970,800. These are the minimum and maximum amounts, respectively, that you can borrow when taking out this type of government-guaranteed loan.

Conventional loan limits

If you want a conventional loan, you’ll need to know the floor and ceiling amounts for these types of loans. Conventional loans follow the conforming loan limits set by the Federal Housing Finance Agency (the same agency that controls Fannie Mae and Freddie Mac). 

In 2023, the floor for a conventional loan is $726,200, and the ceiling is the same as it is for FHA—$1,089,300. Some areas may have different floor and ceiling amounts, as this is based on the average selling price of homes in an area.

FHA vs. Conventional Loan: Mortgage Insurance

Mortgage insurance is a cost you may have to pay when you borrow money to buy a house, depending on the type of loan and the down payment amount. Many homebuyers with a smaller down payment or a lower credit score will use an FHA mortgage, making it a goal to refinance to a conventional mortgage in the future. Refinancing can eliminate the need for PMI, which FHA mortgages require.  

When you refinance, you will need to have your home or investment property appraised, and if you can show 20% equity in the property, you can avoid PMI. It’s not uncommon for a property owner to pay private mortgage insurance since, in many cases, they only pay it for a short period.

You don’t need PMI with conventional loans if you can make the 20% down payment. Those who can’t should plan on having PMI for at least part of the time they’re making loan payments. 

This information will help you better understand mortgage insurance requirements for conventional and FHA loans: 

FHA loan mortgage insurance

The up-front MIP is a cost that is required with an FHA mortgage, regardless of the amount you put down. This is a cost on top of your typical mortgage closing costs and is usually rolled into your borrowed mortgage balance. So you are paying interest on this over the life of the mortgage. Currently, the MIP charge for a 30-year term is 1.75% of your loan amount.

Mortgage insurance is a monthly payment that’s added on top of your mortgage payment. The FHA program requires you to pay mortgage insurance for at least five years before you can have it removed.

Conventional loan mortgage insurance

Unlike FHA loans, you only have to pay mortgage insurance with conventional loans until you reach a 78% loan-to-value ratio or have 22% equity in the property. So if you can make a 20% down payment and you have a good credit score, you won’t be responsible for PMI. 

The amount of these premiums differ between an FHA and a conventional loan, and typically, you’ll pay more for an FHA loan PMI than a conventional loan PMI. Your PMI percentage can range between 0.5% and 2% with a conventional loan because it depends on various factors related to your finances and credit history. 

FHA Loans: Pros and Cons

FHA loans have pros and cons; your financial situation will determine if this is the right mortgage. 

Here are some of the pros and cons to consider before you take advantage of an FHA loan:

Pros

These are the best parts of taking out FHA loans:

• Low down payment: You can put down as little as 3% to 3.5% when you use an FHA loan. This can make saving the money you need easier to get the house you want.
• Low credit score: The credit score needed to qualify for an FHA loan is much lower than what you’ll need for a conventional loan. This means that even if you’ve had some trouble with your credit score, you can still be accepted for an FHA loan.
• Lenient debt-to-income ratio: An FHA-backed mortgage requires a more lenient debt-to-income ratio than a conventional loan. This means you can have a higher debt load or make less money and still meet the qualification requirements for this type of mortgage.

Cons

These are the downsides of taking out FHA loans:

• Higher up-front costs: Because you have to pay the MIP upfront along with other fees, an FHA loan has higher up-front costs than a conventional loan.
• Mortgage insurance: No matter what you do, you’ll have to pay mortgage insurance for at least five years when you have an FHA loan. This increases the amount of interest you’ll pay on the loan amount.
• Riskier to sellers: Sellers may see an FHA loan as a higher risk, since approval requirements are less stringent than they are with a conventional loan. So if the seller has two offers to consider, they may choose to accept one from a buyer with a conventional loan over one with an FHA mortgage.

Conventional Loans: Pros and Cons

Like any other loan, there are pros and cons to using a conventional loan for your mortgage.

Take a look at some of them to help you decide if a conventional loan would meet your needs:

Pros

These are a few pros of conventional loans:

• Avoid PMI: By putting 20% down, you can avoid paying PMI using a conventional loan. There’s no way to avoid PMI with an FHA loan.
• Option for more money: Using a conventional loan means you have access to more money. The floor for conventional loans is much higher than it is for FHA loans.
• Lower monthly payment: If you use a conventional loan, you might have a lower mortgage payment because you won’t have to pay PMI, and you’ll have to put more money down. You may also have a lower interest rate because you most likely have a higher credit score.

Cons

Think about these cons before choosing a conventional loan:

• Higher credit score: Your credit score will need to be over the 600 range to qualify for a conventional loan. This is much higher than the credit score requirement of 500 for an FHA loan.
• Strict eligibility requirements: Some eligibility requirements for a conventional loan are stricter than they are with an FHA loan. Aside from having a higher credit score, you may also need to have a lower debt-to-income ratio and a steady income history, with no bankruptcies or foreclosures.
• Riskier to banks: An FHA loan is insured by the government, so lenders might feel more comfortable offering one over a conventional loan. While the borrowing is more stable with conventional loans, some lenders might like the guarantee that comes with an FHA loan.

FHA vs. Conventional Mortgage: Which One Should I Choose?

Deciding between conventional and FHA loans depends on your situation and the property you want to buy. While you can build wealth using FHA loans, these types are better for buying a primary residence. A conventional loan may be a better option if you’re interested in investing. 

There are several reasons an FHA loan might work for you, since FHA loans require fewer stipulations and you can get approved if you have a low credit score or don’t have much money to put down. 

On the other hand, if your credit score is high and you want to purchase a property with a higher down payment, the conventional loan route might be the best choice.

Frequently Asked Questions

What is the Federal Housing Administration? 

The Federal Housing Administration (FHA) is the government agency that provides insurance on mortgages issued by FHA-approved lenders. The FHA backs loans on single-family, multifamily, and residential care properties across the U.S.

Are FHA loans more expensive than conventional loans? 

The cost of the loan depends on the down payment and how much money is borrowed to purchase your property, so an FHA loan could cost the same as a conventional loan. You can use a mortgage calculator to estimate and compare costs. 

Why do sellers prefer conventional loans over FHA loans? 

Some sellers may prefer buyers with conventional loans because they have more stringent requirements and may be seen as less risky. 

Additionally, FHA loans may have more strict inspection and appraisal requirements, and sellers will need to address any issues that come up during the inspection or appraisal. Many sellers prefer to avoid potential setbacks, and as a result, may go with a conventional mortgage buyer instead. 

Why should someone choose an FHA loan? 

Every borrower is different, and there are a lot of reasons why someone might choose an FHA loan. The biggest reason may be that FHA loans have lower down payment and credit score requirements, which can be helpful for first-time buyers. 

Are there other government-backed loans available? 

Yes! In addition to FHA loans, the government also offers Veterans Affairs (VA) loans and U.S. Department of Agriculture (USDA) loans. 

VA loans are for members of the armed services, their spouses, or beneficiaries. VA loans do not require a down payment or PMI. USDA loans are available for low- to moderate-income buyers who live in rural areas and don’t require a down payment.  

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.