FHA loans and conventional loans are among the most common mortgage loans for homebuyers.
Each type has its own benefits and drawbacks, and the decision to choose one or the other depends on a borrower’s personal finances and goals.
What's in this article?
FHA loans offer more flexible lending requirements, while conventional loans offer greater benefits for borrowers with a higher credit score.
Let’s take a look at FHA vs. conventional loans to help you determine which mortgage loan is better suited for your unique life goals.
What is an FHA loan?
FHA loans are insured by the Federal Housing Administration. Congress created the FHA in 1934 during the Great Depression to help more borrowers qualify for homeownership.
Because these loans are backed by the government, they are less of a risk to lenders and have more flexible lending requirements.
For example, FHA loans have a lower minimum credit score and minimum down payment than most conventional loans.
FHA loans help low-to-moderate income families qualify for a mortgage, so they are most popular with first-time homebuyers. However, you still can qualify for this loan type even if you aren’t a first-time buyer.
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What is a conventional loan?
Conventional loans are not backed by a government entity, but the most common conventional loans are backed by Fannie Mae and Freddie Mac, two government-sponsored enterprises.
Fannie Mae and Freddie Mac purchase these conventional loans from private lenders such as banks or other financial institutions, and set the regulations and guidelines for the loans.
Because they are not backed by the government, they generally have stricter lending requirements.
Differences between FHA vs. conventional loans
The main differences between FHA vs. conventional loans involve credit score and down payment requirements.
Conventional loans require higher credit scores, typically 620 or higher, while FHA loans may allow a credit score as low as 500.
The minimum down payment amounts may be similar, with some conventional loans requiring at least 3% and FHA requiring at least 3.5%, but the circumstances surrounding these down payments differ greatly.
For example, if you put down 20% for a conventional loan, you don’t have to pay private mortgage insurance (PMI) throughout the life of the loan.
But no matter how much you put down for an FHA loan, you have to pay an upfront mortgage insurance premium (MIP), as well as annually.
Additionally, FHA and conventional loans have different property standards. FHA loans are more strict, while conventional loans are more liberal.
When do FHA loans make sense?
FHA loans allow borrowers with not-so-great credit to qualify for a mortgage.
If you’re still working on your credit score but are ready to purchase a home, you may be able to qualify for an FHA loan.
An FHA loan makes sense if you’re a first-time buyer looking for an affordable mortgage option.
When do conventional loans make sense?
Conventional loans can offer bigger long-term savings, and more loan options, for borrowers with better credit who can afford a more substantial down payment.
If you’ve been working on your credit score and saving for a down payment, a conventional loan may be the right choice.
Conventional loans also can be used to purchase rental or vacation properties in addition to primary residences, and can allow you to purchase a more expensive home.
Requirements for FHA loans
FHA loans are more flexible when it comes to credit score, but can be more strict in other areas.
Requirements for FHA loans include:
- Credit score 500-579 with 10% down
- Credit score 580 and up with 3.5% down
- Debt-to-income (DTI) ratio up to 50%
- Must pay MIP
- Property must be primary residence
- Property must meet FHA requirements for safety and security
A borrower’s debt to income ratio can be calculated by dividing your total monthly debt by your gross monthly income, and then multiplying the total by 100.
The result is your debt to income percentage, which lenders use to determine your debt level.
Requirements for conventional loans
Conventional loans have more strict documentation requirements in exchange for more loan options.
Requirements for conventional loans include:
- Credit score of 620 or higher
- Maximum debt to income of 43%
- Down payment as low as 3%, but if you put down 20% you’ll eliminate private mortgage insurance
- Higher loan limits
- Property can be primary residence, second home, or rental home
- Home must be safe, sound, and secure
While lenders generally allow credit scores as low as 620, conventional loan interest rates will be better for those with a higher credit score.
Those with a higher credit score can expect greater savings with a conventional loan.
Do sellers prefer an FHA or conventional loan?
Some sellers prefer conventional loans over FHA loans because of timing.
FHA loans require an FHA appraisal, which requires sellers to address whatever issues pop up during this step.
An FHA appraisal is similar to a home inspection, but the FHA requirements are more strict.
As a result, this step can add both extra time and uncertainty to the closing process, and most sellers just want to move through the process as quickly as possible.
How do I know which loan is right for me?
The decision between an FHA vs. conventional loan is a personal decision, based on your finances and short and long-term homeownership goals.
This decision is best made with the guidance of a trusted mortgage lender, who can help you move through the process smoothly and show you all your available loan options.
Plus, a mortgage lender can help you get pre-approved to give your home search a boost.
If you’re ready to get started, reach out to the loan officers at Compass Mortgage.
Our team is set apart by the experience we can deliver. We treat everyone with love and respect as we believe each person has infinite worth, and will go above and beyond to help you meet your homeownership goals.