With such a wide array of existing loan options, it is crucial that home buyers understand which products and programs will work best for them. FHA loans and conventional loans are two of the most common options for homebuyers – but what’s the difference?
Whether you are just starting out your research or are nearing the application process, this guide will help you to understand the differences between FHA and conventional loans. In this post, we’re covering everything from qualifications and requirements to the pros and cons of each loan type. Better yet, we’re even sharing our expert opinion on how to determine which option is right for you.
What Is an FHA Loan?
An FHA loan is a type of low down payment government loan insured by the Federal Housing Administration, an office of the U.S. Department of Housing and Urban Development. These loans have less restrictive qualifications than conventional loans, making it a good choice for home buyers who may be unable to come up with a significant down payment or who have a low credit score.
What Is a Conventional Loan?
The most common type of loan, conventional mortgages are private-sector loans that follow the guidelines set by Fannie Mae and Freddie Mac. These two widely known federally backed home mortgage companies were created to provide stability and affordability to the mortgage market. As opposed to FHA loans, conventional loans are not government backed and therefore have stricter requirements.
Borrowers can choose between 15-year, 20-year and 30-year mortgages. For a potential borrower with good credit and money set aside for a down payment, conventional loans are a very affordable option in the long run.
How to Qualify for FHA and Conventional Loans
From the minimum down payment to the credit score requirements, there is no doubt that FHA loans are easier to qualify for than conventional loans. To understand where you may fit as a borrower, start by understanding the distinctions that can be made between each loan type’s requirements.
Debt-To-Income Ratio
Your debt-to-income ratio (DTI) is the percentage of your monthly gross income that goes toward paying debts. To qualify for a conventional loan, your DTI should be no more than 43%. However, some lenders will accept a max DTI between 45% and 50% for conventional loans.Citation As for FHA loans, the recommended DTI to qualify is 50% or less.Citation Again, this percentage may vary by your credit score or the specific lender’s expectations.
Minimum Down Payment
A minimum down payment is the amount of cash that a buyer is required to put down to qualify for a mortgage loan. For an FHA loan, a credit score of at least 580 will allow you to put down as little as 3.5%. With a score of 500 to 579, the minimum down payment will be 10%.
The minimum down payment for conventional loans can be as low as 3%. However, most buyers using conventional loans will typically put down 20% because anything less requires an additional payment for private mortgage insurance (PMI).Citation
Credit Score
Lenders will use your credit score to assess your creditworthiness. On average, the typical approved credit score for an FHA loan is 580 or higher.Citation The minimum credit score requirement for conventional loans is 620. The requirement is higher for conventional loans compared to FHA loans because they are not government backed and therefore the lender is taking on more risk.
Note that borrowers with credit scores of 720+ typically pay less per month with conventional loans, whereas borrowers with credit scores below 720 typically pay less per month with FHA loans.
Pros and Cons of FHA and Conventional Loans
| Pros of FHA Loans | Cons of FHA Loans |
| Easier to qualify for | Require slightly higher down payments |
| Low down payment of 3.5% | Stricter property standards (i.e., can’t always be used to purchase a second home or investment property) |
| More forgiving of past bankruptcies / foreclosures | Mortgage insurance mandatory regardless of down payment |
| Allows non-occupant co-borrower to qualify for a loan | Mortgage insurance cannot be canceled unless borrower refinances into a conventional loan |
| Less restrictive DTI requirements | Non-occupant co-borrower must be a relative to qualify for a loan |
| Flexible credit review | End up paying more over the life of the loan |
| Fixed or adjustable rate | |
| Limited closing costs / seller can help pay closing costs | |
| Available to individuals with low credit scores or no credit history | |
| Special 203(k) program for home repairs |
| Pros of Conventional Loans | Cons of Conventional Loans |
| Less expensive than FHA loans | Harder to qualify |
| Down payment as low as 3% | Require higher credit scores |
| Can be used to purchase a primary residence, second home or investment property | Require PMI when the down payment is less than 20% |
| Allows any non-occupant co-borrower to qualify for a loan | |
| No upfront mortgage insurance | |
| Potential for lower mortgage insurance rates or no mortgage insurance at all | |
| Stable interest rates | |
| More appealing to sellers | |
| Shorter underwriter approval process |
All About Mortgage Insurance
In the event that you default on your loan, mortgage insurance will protect the lender. As for the buyer’s side, mortgage insurance is designed to make it possible for borrowers to make a much smaller down payment and still qualify for a home loan.