FHA Loans vs. Conventional Loans

So, you're ready to buy a home. But which loan program is the one for you? FHA and conventional home loans are both excellent products, whether you’re a first-time buyer or a home buying pro. But since these are two different programs, they have two different sets of requirements. Understanding how these mortgages are different can help you decide which is the one for you.

What's an FHA Home Loan?

An FHA home loan is a government-sponsored mortgage program insured by the Federal Housing Administration (FHA). The FHA doesn’t issue loan funds to borrowers; you'll have to go through an FHA-approved mortgage lender to apply for an FHA loan.

What is a Conventional Loan?

A conventional mortgage loan is one of the most popular home loan programs for home buyers. Conventional loans are backed by Fannie Mae and Freddie Mac, two government-sponsored enterprises that buy mortgages from banks and other lenders. Many home buyers choose a conventional loan when it's time to purchase a new home or refinance an existing mortgage because they offer a lot of flexibility and options, including fixed-rate and adjustable-rate mortgages, as well as mortgages with flexible terms (15 years, 20 years, 30 years, etc).

What's the Advantage to These Loans?

FHA Loan Advantages

First-time home buyers are fans of FHA home loans because they have lower credit score and down payment requirements. If you've struggled with credit problems in the past (such as a foreclosure or bankruptcy), you may find that it’s easier to get an FHA loan with a lower FICO score compared to a conventional loan.

Conventional Loan Advantages

Although conventional loans can be trickier to get due to higher credit score and down payment requirements, they offer more flexible repayment terms compared to FHA loans. And unlike FHA loans (which are only for primary residences), conventional loans can be used to purchase different types of real estate, like vaction homes or investment properties.

Here are other details you'll need to consider

Like all loan programs, FHA and conventional loans have many factors that can make them more desirable for home buyers. Requirements like down payment, credit score, and even home type can determine which is better for you.

Down Payment Requirements

Another difference between conventional loans and FHA loans is their down payment requirements. FHA home loans require a minimum down payment of 3.5%*. The traditional down payment for a conventional loan is 20%, but you don't necessarily need to put down that much to qualify for a conventional loan.

Credit Scores and Mortgage Rates

One of the benefits of using an FHA loan is that credit score requirements are typically lower than for conventional loans. The U.S. Department of Housing and Urban Development (HUD) sets credit guidelines for FHA home loans; however, each lender can set their own credit score requirements

Your mortgage rate for either loan depends on several factors, such as your credit score and the amount of your down payment. For the most part, FHA loan rates are comparable with those of a conventional loan.

Debt-to-Income Ratio

Debt-to-income (DTI) ratio can sound complicated, but it's just the percentage of your monthly income that goes toward debt repayment. Mortgage lenders use DTI ratios to determine how risky a transaction is, and they generally view a lower DTI as more favorable. Typically, FHA home loans allow for a higher DTI ratio than conventional loans. If you have compensating factors, like a high credit score or large cash reserves, you may get approved with a higher DTI ratio.

Mortgage Insurance

Borrowers who purchase a home with less than a 20% down payment will have to pay private mortgage insurance (PMI) with a conventional loan. Mortgage insurance is also required on FHA home loans with less than 20% down. FHA loans also have a one-time upfront mortgage insurance premium paid at closing.

With a conventional loan, mortgage lenders remove PMI once the property has at least 20% equity. With an FHA loan, mortgage insurance is for the life of the loan if you put down less than 10%. If you want to remove your mortgage insurance once you reach 20% equity, you'll have to refinance the loan.

Loan Limits

Both FHA and conventional home loans have loan limits that vary by county or state. For 2021, the FHA loan limit for a single-family residence is $356,362, and $822,375 in high-cost areas. The loan limit for a conventional home loan is $548,250, and $822,375 in high-cost areas.

Property Standards

Not all properties qualify for an FHA home loan. You can only use FHA home loans to finance a primary residence. This includes single-family homes, townhouses, manufactured homes, and condos in approved complexes. A conventional home loan can be used for primary residences, vacation properties, and investment properties.

How to Apply for an FHA or Conventional Home Loan

Ready to get started? Our loan experts can help you find the loan you've been looking for. We're here to answer your questions and help you get started on the application process.

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*Sample loan scenario shown for educational purposes (rate may not reflect current market Conditions): Sales Price: $350,000; Loan Amount: $343,660; Down Payment: $12,250; Fixed Interest Rate: 3.875%; Annual Percentage Rate (APR): 5.062%; Principal and Interest Payment: $1,616 (payment shown does not include taxes and insurance); MI: $239; Purchase Transaction; 740 Credit score; Single Family Residence.