FHA Loans vs. Conventional Loans: What’s the Difference?

How FHA Loans and Conventional Loans Measure Up

FHA Loans vs. Conventional Loans: An Overview

Consumers qualify for various types of mortgages based on their financial profiles. A lot of mortgages tend to be conventional loans. But there are others that are backed and insured by the Federal Housing Administration (FHA).

While both allow consumers to finance the purchase of a home, there are several key differences between FHA loans and conventional loans.

FHA loans make homeownership possible and easier for low- to moderate-income borrowers who may not otherwise be able to get financing because of a lack of or a poor credit history, or because they have limited savings. Those who qualify for an FHA loan require a lower down payment. And the credit requirements aren’t nearly as strict as other mortgage loans—even those with credit scores below 580 may get financing. These loans are not granted by the FHA itself. Instead, they are advanced by FHA-approved lenders.

People with established credit and low levels of debt, on the other hand, usually qualify for conventional mortgages. These loans are generally offered by private mortgage lenders like banks, credit unions, and other private companies. Unlike FHA loans, conventional mortgages aren’t backed or secured by the government.

Key Takeaways

  • People with good credit and low levels of debt usually qualify for conventional mortgages.
  • People with little cash for a down payment and a modest credit rating typically qualify for Federal Housing Administration (FHA) mortgages.
  • FHA loans require a lower minimum down payment and lower credit scores than conventional loans.
  • FHA loans are backed by the government, unlike conventional loans.
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FHA Loans vs. Conventional Loans

Investopedia / Alison Czinkota

About FHA Loans

FHA loans are federally insured and issued by FHA-approved lenders, including banks, credit unions, and other lending companies. FHA loans are intended for borrowers with limited savings or lower credit scores.

FHA loans can be used to buy or refinance single-family houses, multifamily homes with up to four units, condominiums, and certain manufactured and mobile homes. There are also specific categories of FHA loans that can be used for new construction or to finance the renovation of an existing home.

Because FHA loans are federally insured—which means that lenders are protected if a borrower defaults on their mortgage—these lenders can offer more favorable terms, including lower interest rates, to borrowers who might not otherwise qualify for a home loan. This means it’s also easier to qualify for an FHA loan than for a conventional loan.

The qualifying standards of FHA loans make home buying more accessible for a greater number of people. As of 2021, you can borrow up to 96.5% of the value of a home with an FHA loan. FHA mortgage applicants with credit scores as low as 580 may be approved for a home loan—provided that they have enough to cover the 3.5% down payment requirement. Those whose credit scores fall below 580 may still qualify but generally need to put down a minimum of 10% of the purchase price. Many lenders require FHA mortgage applicants to have credit scores from 620 to 640 for approval.

FHA loans may also have additional closing costs that aren’t required by conventional loans.

About Conventional Loans

A conventional loan is a mortgage that is not backed by a government agency. Conventional loans are originated and serviced by private mortgage lenders, such as banks, credit unions, and other financial institutions. Conventional loans present the most risk for lenders since the federal government does not insure them. For this reason, lenders extend conventional mortgages to applicants who have the strongest financial profiles. Conventional down payment requirements range from 3% to 40%, depending on the mortgage product.

To qualify for a conventional loan, consumers typically must have stellar credit reports with no significant blemishes and credit scores of at least 680. Conventional loan interest rates vary depending on the amount of the down payment, the consumer’s choice of mortgage product, and current market conditions. Most conventional loans come with fixed interest rates, which means that the rate never changes throughout the life of the loan. Borrowers are able to refinance if rates change.

Conventional loans can be divided into two categories: conforming and nonconforming loans. Conforming conventional loans follow the lending standards set forth by the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corp. (Freddie Mac).

FHA Loan vs. Conventional Loan
 FHA Loan  Conventional Loan
Lower credit score to qualify Stricter lending requirements
Mortgage insurance mandatory Mortgage insurance required if down payment is less than 20%
Down payment of at least 3.5% Down payment range 3% to 20%
Loans backed by the government Loans not backed by the government
Can only be used to finance a primary residence Can finance a primary residence, vacation home, rental property, etc.

Special Considerations

Mortgage insurance

Borrowers may be required to pay mortgage insurance, depending on the mortgage terms and the amount of the down payment. Unlike other types of insurance, mortgage insurance protects the lender—not the policyholder—if the borrower stops making payments and defaults on their financial obligations.

Mortgage insurance is built into every FHA loan. There are two premiums that must be paid. The first is an up-front payment, which can be rolled into the loan and paid throughout its life. The second is a monthly premium. Borrowers who can put down 10% or more pay these premiums for 11 years. Anyone who makes a down payment of less than 10% must make these premium payments for the duration of their mortgage.

Most lenders prefer to issue conventional loans for no more than 80% of the market value of a home—the equivalent to making a 20% down payment. The percentage of the home’s value that is represented by the amount of the loan is indicated by the loan-to-value (LTV) ratio. For example, a borrower who puts down 15% ($45,000) on a $300,000 home requires a loan of $255,000. This would yield an LTV ratio of 85%. Lenders require an LTV ratio of 80% or less as a way of protecting themselves against the risk that the borrower will fail to repay the mortgage. This is why people with conventional mortgages who make less than a 20% down payment pay mortgage insurance—also called private mortgage insurance (PMI)—until their LTV ratio reaches 80%.

PMI can cost from 0.3% to 1.5% of your loan amount annually. Like other types of mortgage insurance, PMI is paid for by the borrower and is intended to protect the lender from experiencing financial loss if they are forced to foreclose on the property. PMI proceeds may be used by lenders to cover the costs associated with reselling a home that is in foreclosure.

For a conventional loan, PMI can be canceled once a borrower pays down enough of the mortgage’s principal.

Pros and Cons of FHA Loans

FHA loans require a lower minimum down payment and a lower credit score than many conventional loans. FHA loans are designed for low- to moderate-income borrowers who otherwise might not qualify for a conventional loan. These benefits make them popular with first-time homebuyers.

While FHA loans require lower down payments and credit scores than conventional loans, they do carry other strict requirements. Mortgage insurance is required for all FHA loans and is collected for 11 years or until the end of the loan term, regardless of the equity in the home.

Another limitation of FHA loans is that they can only be used to purchase a primary residence.

Pros and Cons of Conventional Loans

Conventional loans are not limited to purchasing a primary residence. For example, eligible borrowers can use the loan to buy a rental property or vacation home. Lenders of conventional mortgages typically only require borrowers to purchase mortgage insurance when they can’t come up with a 20% down payment, but once a borrower pays down enough of the mortgage’s principal, insurance can be canceled.

Because conventional mortgages are not guaranteed by the government, they typically have stricter lending requirements, including a higher credit score and a lower debt-to-income (DTI) ratio.

Other Government-Backed Loans

FHA loans are not the only type of government-backed loans. There are two other types of government agency-insured loan programs: VA loans and USDA loans.

Veterans Affairs (VA) loans are backed by the U.S. Department of Veterans Affairs. These loans are available to qualified members of the armed services, their spouses, and other beneficiaries. VA loans don’t require a down payment and typically don’t charge mortgage insurance.

Loans are available for borrowers in rural areas through the U.S. Department of Agriculture (USDA). They are intended for low- to moderate-income homebuyers and don’t require a down payment. There may also be more flexibility with credit score requirements.

What is an FHA loan?

Federal Housing Administration (FHA) loans are guaranteed by the government and designed for homeowners who may have lower-than-average credit scores and lack the funds for a big down payment. They require a lower minimum down payment and a lower credit score than many conventional loans. FHA home loans are issued by FHA-approved lenders.

What is a conventional loan?

Conventional loans are home loans that are not offered or secured by the government. Borrowers with established and excellent credit, and who are on a solid financial footing, typically qualify for conventional mortgages.

What credit scores are required for conventional loans vs. FHA loans?

To qualify for a conventional loan, you’ll need a credit score of at least 680. Borrowers with credit scores as low as 580 may be approved for an FHA loan. If your credit score is lower, you may still qualify, but you will need a minimum of 10% of the home’s value for a down payment.

Article Sources
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  8. U.S. Department of Veterans Affairs. “Purchase Loan.” Accessed Nov. 14, 2021.

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  10. U.S. Department of Agriculture, Rural Development. “Section 502 Direct Loan Program’s Credit Requirements,” Pages 16–22. Accessed Nov. 14, 2021.