Conventional versus FHA loans—find out the difference
When comparing an FHA loan vs. a Conventional loan: which is better? FHA loans are designed for homebuyers with lower credit scores and smaller down payments, requiring monthly mortgage insurance. Conventional loans have a higher credit score requirement and may allow you to avoid mortgage insurance with a larger down payment. Determining which is ‘better’ depends on your needs and situation.
Conventional vs. FHA loan: a side-by-side comparison
Here are the factors to consider when choosing between an FHA loan vs. a Conventional loan:
| Feature | FHA loan | Conventional loan |
|---|---|---|
| Definition | Insured by the Federal Housing Administration (FHA), a government agency | Not insured by the government; issued by private lenders |
| Down payment | As low as 3.5% | Typically requires a minimum of 3% |
| Credit score | Typically requires a lower credit score—540 with a 10% down payment and 580 with a 3.5% down payment | Typically requires a credit score of 620 or more |
| Mortgage rates | Generally slightly lower | Generally slightly higher |
| Loan limit | Generally lower loan limits that vary by county | Higher loan limits that vary by county |
| Debt-to-income ratio (DTI) | The maximum FHA loan DTI requirement is 43% for most people, however a higher DTI can get approved. | The maximum Conventional loan DTI requirement is up to 50% for conforming loans. |
| Mortgage insurance | Required for the life of the loan | Required if your down payment is less than 20% |
| Escrow account | Most government-backed loans require escrow. | May be required when you put down less than 20% |
| Property type | Primarily for a primary home | Can be used to buy a primary home, vacation or investment property (usually requiring a larger down payment and higher interest rate for second homes and investment properties) |
Let’s find the loan that fits your life.
Is a Conventional loan right for you?
Here are some advantages of a Conventional loan:
- Low down payment. The minimum down payment is just 3 percent.
- No mortgage insurance with a higher down payment. You can avoid paying monthly mortgage insurance if you put down 20 percent or more.
- High loan limits. Higher limits may allow you to purchase in a high-cost area without having to use a Jumbo loan, which typically has a larger down payment requirement.
Many people think FHA loans are the most affordable option, but Conventional loans can be just as, if not more, affordable if you meet credit score requirements. While FHA loans are known for low down payments, Conventional loans can require as little as 3 percent down. If your credit score is 620 or higher, you may qualify for a Conventional loan with a smaller down payment.
Here are some disadvantages:
- Potentially harder to qualify for. Requirements are usually more stringent than government-backed loans.
- Higher credit score requirement. A 620 FICO score is required, compared to the 540 minimum for an FHA loan.
- Mortgage insurance. If your down payment is less than 20 percent, you’ll need to pay mortgage insurance monthly or in a lump sum at closing.
If you’re paying mortgage insurance, you can request removal once your mortgage principal balance reaches 80 percent of your home’s original sale price. This usually requires a minimum of two years’ on-time payment history. Mortgage insurance will automatically be removed once your balance reaches 78 percent of your home’s original sale price.
Is an FHA loan right for you?
Here are some advantages of an FHA loan:
- Low down payment. The minimum down payment is just 3.5 percent.
- Lower credit score requirements. A minimum FICO score of 580 is required for a 3.5 percent down payment. If your score is between 540 and 579, you may still qualify with 10 percent down.
- Potentially easier to qualify for. FHA loans have more flexible requirements compared to Conventional loans, making them friendly to first-time homebuyers.
- Assumable loan. An FHA loan can be assumed by a new buyer (taken over with the same rate and terms), which can be beneficial in a rising interest rate environment.
One common misconception is that an FHA loan is riskier because it can be easier to qualify for. Thankfully, this is not the case. FHA loans have been around for nearly one hundred years and are government-backed. Choosing an FHA loan can make more sense if you’re a first-time homebuyer, if your credit score is on the lower end or if you’re looking for more flexible loan requirements.
Here are some disadvantages:
- Mortgage insurance premiums (MIP). FHA loans require both an upfront MIP at closing and annual MIP payments, regardless of your down payment amount.
- Long-term MIP. You’ll pay MIP for your full loan term if your down payment is less than 10 percent.
- Loan limits. FHA loan limits are generally lower than Conventional loan limits, which may make it harder to purchase a higher-priced home.
If you put down less than 10 percent, FHA MIP is included for the life of the loan. In this scenario, FHA mortgage insurance can’t be cancelled. However, some homeowners explore refinancing to a Conventional loan to remove their mortgage insurance.
Need help deciding on a loan?
You have plenty of decisions to make when buying a home—from where to live to what color to paint the walls. Let us help you find the right loan for your financial situation. Contact your local Guild loan officer for one-on-one guidance.
The above information is for educational purposes only. All information, loan programs and interest rates are subject to change without notice. All loans subject to underwriter approval. Terms and conditions apply. Always consult an accountant or tax advisor for full eligibility requirements on tax deduction.