FHA vs Conventional Loan Mortgages

FHA loans and conventional mortgages are common mortgages used to finance homes. Whereas Federal Housing Administration (FHA) mortgage loans are insured by the government, conventional loans come solely from private lenders such as credit unions, banks, and mortgage brokerages. FHA loans have lower qualifying standards and lower down payment criteria than conventional loans. Conventional mortgages, however, have lower insurance premiums and can be used for other purposes besides primary residence financing.

Whether you’re unsure about the difference between FHA and conventional loans, are buying vacation rental property, or require other forms of financing for your property, consulting a leading mortgage broker near you can simplify the process. At The Mortgage Shop, you can borrow a mortgage loan perfect for your needs, goals, and financial circumstances.

Here we’re going to outline everything you need to know about the FHA loan vs conventional loan mortgages, including critical differences and similarities, advantages and disadvantages, and which loans are right for you.

Eligibility Requirements for FHA Loans and Conventional Loans

The main differences between Federal Housing Administration (FHA) loans and conventional loans are the eligibility requirements and ease of access. Compared to conventional loans, FHA loans are designed to help first-time home buyers and those with financial or economic difficulties. The Federal Housing Administration (FHA) insures loans for single-family and multi-family households.

Conventional loans, meanwhile, are better suited for buyers with good credit scores who can afford a bigger down payment to minimize insurance and paperwork. These loans are privately insured, unlike the government-backed loan from the FHA.

Ensure You’re Eligible for a Conventional or FHA Loan

Various eligibility requirements impact whether you can take out an FHA home loan or conventional home loan on your rental property, vacation home, or primary residence. Unlike conventional loans, FHA loans require that the home loan is for your primary residence.

Both loan types require that you are employed and have income verification. This indicates that you can handle a monthly mortgage payment, monthly mortgage insurance, and mortgage interest rate over the life of the loan.

Credit Score & Down Payment Criteria for FHA & Conventional Loans

Both FHA and conventional loans reward borrowers with strong credit scores, although FHA loans in particular are best for any borrower with a lower credit score. If you are applying for an FHA home loan, remember that a higher credit score means a lower down payment.

FHA loans require:

• 3.5% down payments for FICO® credit scores 580 and above
• 10% down payments for any FICO® credit scores 500 to 579

Unlike FHA loans, conventional loans require:

• 3% down payment minimum
• FICO® credit scores of 620 or above (680 is preferred)

In some cases, sellers prefer conventional loan borrowers because they tend to come from a better financial situation and have a stronger credit history. They can also afford a larger down payment amount. Depending on the lenders, lower credit scores may be an immediate red light. Remember, if you have a lower credit score, it’s always possible to improve it over time. 

Just remember, that your credit score and required down payment are inextricably linked. The better the FICO® score, the smaller the down payment required.

If you’re concerned about a minimum credit score, down payment, loan limits, or affording mortgage payments in general, contact a top mortgage broker near you. Many conventional and FHA-approved lenders can work with your financial situation.

Debt to Income Ratios for Conventional and FHA Loan Mortgages

The Debt-to-Income (DTI) Ratio is a measure of a borrower’s debts and income. This ratio helps mortgage lenders determine if borrowers can actually afford a mortgage. Will there be problems with the loan balance? How much interest will accrue over the life of the loan?

Conventional and FHA-approved lenders will look at your DTI as indicating your ability to make monthly payments.

The Debt-to-Income Ratio factors in your:

• Credit card payments
• Mortgage and/or rent payments
• Recurring costs and fees, and
• Other loans (i.e., student or auto)

Once you’ve added these expenses up, divide them by your gross monthly income to find your debt-to-income ratio. For any FHA loan, you must keep your DTI ratio at or below 45% depending on your FICO® score. FHA loans typically allow you to go as high as 50%.

Interest Rates and Closing Costs for a Conventional vs FHA Loan

Conventional loan interest rates are typically fixed, but this can vary based on the borrower’s down payment, market factors, and loan terms. With an FHA loan, the interest is usually lower. This is possible because the FHA loan is insured by the federal government.

When it comes to the closing costs of FHA vs conventional loans, there can be many. A borrower should typically expect to pay origination fees, title searches, appraisal fees, taxes, title insurance, and more as closing costs. Unless they shoot up like a rocket, mortgage closing costs are usually between 2% and 6% of the property price.

Unlike a conventional mortgage, the borrower of an FHA loan will also have to pay FHA mortgage insurance premiums (monthly premiums), as well as an upfront mortgage insurance premium based on the FHA mortgage insurance requirements. These costs can be factored into your closing costs or as part of your mortgage.

Whether you need an FHA loan for your home or have a rental real estate investment, be sure to discuss your financing and insurance options with an expert.

Mortgage Insurance for Conventional and FHA Loans

Because FHA loans have less stringent requirements on down payments and credit history, you’ll have to pay for the lender’s risk some other way. That’s why taking out an FHA loan requires that you pay mortgage insurance. You’ll have to pay premiums for 11 years minimum, sometimes for the loan’s lifetime.

Conventional loans, meanwhile, do not charge mortgage insurance unless you fail to put down at least a 20% down payment. If you do not put down a 20% down payment, you will have to pay private mortgage insurance (PMI). Once your balance on the loan reaches 80% of the property’s initial value (or you have 20% equity), you can stop paying the private mortgage insurance costs.

Both FHA loans and conventional mortgages have their limitations. The loan limits for FHA loans are upwards of $970,000 in affluent areas and a little over $420,000 in low-income areas. Unlike the FHA loan limit, the conventional loan limit is set by the Federal Housing Finance Agency at about $650,000 for most areas in the country.

Pros and Cons of FHA Loans and Conventional Loans

Is a conventional loan better than FHA loans? That all depends on your particular financial conditions, objectives, and external market factors. When it comes to FHA vs conventional loan mortgages, borrowers must consider both benefits and detriments.

Generally, FHA loans can help empower borrowers with uncertain or less-than-ideal economic situations to own a home. Conventional mortgages, by comparison, can be suitable for primary residences, vacation homes, rental properties, and more.

Although FHA loans are easier to qualify for and may have better fixed interest rates, they also come with insurance and more paperwork. Meanwhile, conventional mortgages allow you to pay taxes and insurance directly (and mortgage insurance payments aren’t required). However, you will need a higher credit score and a bigger down payment.

If you’re debating FHA loans and conventional loans, check out the following FAQ.