Conventional loans and FHA loans are two of the most popular loan programs for potential borrowers to achieve homeownership.
If you’re ready to join the millions of homeowners in America but aren’t sure of your options for a mortgage loan, you’ve come to the right page.
Let’s look at these two types of loans—conventional mortgages vs. FHA mortgages—to see the key differences between them and discuss the requirements for eligibility.
What are FHA loans?
Federal Housing Administration loans (FHA loans) are mortgages backed by the government and insured by the FHA.
FHA loans have less restrictive requirements, making them a sensible choice if you’re concerned about saving a minimum downpayment, having a lower credit score, or possibly both.
What are conventional loans?
On the other hand, conventional loans are not guaranteed or insured by any government department or agency. Instead, they’re insured by private mortgage lenders.
A higher credit score is required to qualify for a conventional loan, but they also have a lower debt-to-income ratio (DTI) and downpayment requirements.
These loans are also called conforming loans because they meet Fannie Mae and Freddie Mac standards—government-created enterprises that purchase mortgages from lenders. Either enterprise will hold onto these mortgages or convert them into mortgage-backed securities.
Conventional loans offer either fixed-rate or adjustable-rate mortgages (ARMs). Loan terms for these types of mortgages typically range from 10 to 30 years.
Credit score requirements
The credit score requirements for FHA mortgages are less restrictive than conventional mortgages.
The requirements vary from lender to lender, but conventional loans generally have a minimum credit score of 620. This higher minimum is because the lender is taking on the risk of default and not a government agency like in the case of FHA loans.
Eligibility for an FHA home loan requires a credit score of only 500, but it also comes with strings attached.
For example, a homebuyer with a low credit score would have to offer a downpayment of at least 10%.
Popular opinion says you need 20% for a conventional loan downpayment—but this is only half true.
If you’re unable to secure the 20%, you will have to pay PMI (private mortgage insurance) to protect the mortgage lender in case of default. PMI would typically be included in your monthly payments.
FHA loans can be approved with a low downpayment—as little as 3.5% downpayment—so long as you have a credit score minimum of 580.
Below that score, as we mentioned above, you will need at least a 10% downpayment.
It’s typically recommended that borrowers show around for lenders to get the best interest rate. But does one type of loan come with a better rate than the other?
FHA interest rates tend to run lower but let’s look at the details.
Fixed-rate vs. ARM
A fixed-rate mortgage means you will have the same interest rate for the life of the loan.
With an adjustable-rate mortgage (ARM), there is typically an initial period where the interest rate is fixed. However, once that initial period expires, your monthly payments will vary periodically according to the prevailing interest rate.
Interest rates for conventional loans
Conventional loan interest rates depend on a good credit score and loan-to-value ratio (LTV). LTV refers to the loan amount relative to the home’s value.
Interest rates for FHA loans
Interest rates for FHA loans tend to have lower interest rates when compared to conventional loans. This better rate is possible because the government backing of FHA loans decreases the risk to the lender.
Again, the interest rate you secure with an FHA loan will depend on market interest rates, your credit history and credit score, income, the loan amount, the downpayment you’re offering, and more.
With both types of mortgage loans, there is a maximum amount you are allowed to borrow.
Conventional loan limits
There is a limit to how much funding conventional loans can approve for borrowers.
For example, the 2022 conventional loan limit for one-unit family homes in the lower 48 states is $647,200. Alaska, Hawai’i and high-cost areas in the 48 states have a limit of $970,800.
A borrower who needs a mortgage loan beyond these limits will need to apply for a jumbo loan.
Jumbo loans are considered non-conforming because there is no backing from Fannie Mae or Freddie Mac. In addition, the underwriting guidelines for jumbo loans tend to be stricter because of the greater financial risk to the lender.
FHA loan limits
FHA loan limits are established each year and depend on the geographic location in the U.S. you would like to purchase your home.
For example, low-cost areas (rural areas) have an upper limit of $420,680.
In comparison, high-cost areas (downtown areas of major American cities, for example) have an upper limit of $970,800.
HUD has a web page for FHA mortgage limits to determine your upper limit.
Mortgage insurance premiums
Mortgage insurance is added to protect the lender in cases of default.
A borrower who cannot offer a minimum downpayment of at least 20% will be required to pay for private mortgage insurance (PMI) with a conventional loan.
Mortgage insurance premiums (MIP) are required for FHA loans, also known as FHA mortgage insurance.
If your downpayment is less than 10%, you will usually have to pay MIP for the life of the loan.
Above 10%, MIP will automatically be canceled after 11 years. There will also be an upfront mortgage insurance premium (UFMIP) required which typically amounts to 1.75%.
Conventional loans vs. FHA loans—conclusion
Homebuyers frequently find it challenging to choose the right type of loan. The right decision will have a lot to do with your personal financial situation and preferences.
There are also other factors to consider, including:
- Closing costs
- Primary residence, second home, or investment property
- Refinancing options
- VA loans for veterans or VA loan refinancing,
Whether you are a first-time homebuyer or have purchased a home before—we can guide you through the pre-approval process and many other aspects of the mortgage application process.
We look forward to connecting with you. Our experienced team is here to help you reach your financing goals.