Conventional Loan Vs. FHA: What’s The Difference?
What Is An FHA Loan?
An FHA loan is a home loan backed by the Federal Housing Administration, a government agency created to help home buyers qualify for a mortgage. The FHA provides backing on loans made by FHA-approved lenders, protecting them from the risk of borrower default.
Differences Between FHA And Conventional Loan
Thanks to more lenient credit requirements and a low down payment, FHA loans are a common loan option for first-time home buyers. They’re also suitable for anyone who needs lower credit requirements to get a mortgage.
A conventional loan is a great option if you have a solid credit score and little debt. You can avoid PMI by paying 20% of the loan upfront, which will lower your mortgage payments. If you’re unable to make a large payment upfront, conventional loans are available with a down payment as low as 3%. In most cases, borrowers save money in the long run with a conventional loan because there’s no upfront mortgage insurance fee, and the monthly insurance payments are cheaper. You can also usually request removal of PMI when you reach 20% equity in your home.
To put it simply, FHA loans are generally easier to qualify for, and they allow for lower credit scores. Conventional loans, meanwhile, may not require mortgage insurance with a large enough down payment. Choosing the best loan option for you depends on your personal financial situation. Let’s take a deeper look at credit score requirements, mortgage insurance, loan limits and property standards, as well as interest rates when it comes to FHA loans versus conventional loans.
FHA Loan Vs. Conventional Loan Credit Score
Whether you’re applying for an FHA loan or a conventional loan, your lender will be taking a close look at your credit score. The strength of your credit informs the lender of the relative risk of mortgage default.
FHA Loans Required Credit Score
Since lenders are more protected, they can afford to be more lenient when offering mortgages. This means it’s possible to get an FHA loan with a lower credit score than with other types of loans. At Rocket Mortgage®, you can qualify with a median score as low as 580. With a score of 620 or higher, you may be able to qualify with a slightly higher debt-to-income ratio (DTI).
Conventional Loans Required Credit Score
Conventional loans have stricter requirements than FHA loans. You’ll need a higher credit score – a minimum of 620 – to qualify for a conventional loan than you would with an FHA loan.
FHA Vs. Conventional Mortgage Insurance
Mortgage insurance is an insurance policy that protects the lender if the borrower is unable to continue making payments. Let’s take a look at what mortgage insurance is required for both FHA and conventional loans.
FHA Loans And Mortgage Insurance
To offset a lower required credit score, FHA loans include mortgage insurance as part of the borrower’s responsibility.
FHA loans require two types of mortgage insurance payments:
- An upfront mortgage insurance premium (MIP) of 1.75% of the loan amount, either paid when you close on the loan or rolled into the loan amount.
- A monthly MIP as part of your regular mortgage payments.
If your down payment was less than 10%, you’ll continue to pay monthly mortgage insurance for the life of the loan.
If your down payment was 10% or more, you’ll only have to pay mortgage insurance for the first 11 years of the loan before it's removed.
Conventional Loans And Mortgage Insurance
Private mortgage insurance (PMI) is a type of mortgage insurance unique to conventional loans. Like mortgage insurance premiums do for FHA loans, PMI protects the lender if the borrower defaults on the loan.
You’ll have to pay PMI as part of your mortgage payment if your down payment was less than 20% of the home’s value.
Unlike mortgage insurance for FHA loans, PMI offers different payment options. Borrower-paid PMI, or BPMI, does not require an upfront cost. Depending on the lender or mortgage investor, you can request to have it canceled once you’ve reached 20% equity in your home. In most cases, it’s automatically removed once you reach 22% equity.
Lender-paid PMI, or LPMI, is paid for you by your lender. The lender will raise your mortgage interest rate to incorporate the insurance payment they make on your behalf. This option may result in lower payments, but it’s typically not cheaper over the life of the loan. LPMI can’t be canceled because it’s built into your interest rate.
A third option is single-pay mortgage insurance. Under this scenario, a client pays for all or part of their mortgage insurance policy up front in order to have lower monthly mortgage insurance fees or none at all, regardless of their down payment.
Loan Limits For Conventional And FHA Loans
FHA and conventional loans both come with limits for the amount you can borrow. The loan limit for either loan largely depends on where in the U.S. you want to buy your home.
FHA Loan Limits
The FHA determines its lending limits based on the area you want to live in and the type of property you plan to purchase. FHA loan limits in most counties are generally less than with conventional loans. The lowest your loan amount can be for a 1-unit FHA loan is $420,680, although it can be higher in high-cost areas and if you have more units.
Conventional Loan Limits
Conventional loans offered by Fannie and Freddie come with a standard loan limit for the area where you want to live, and typically offer more than an FHA loan. If you need a loan that exceeds those limits, you may want to consider a jumbo loan. The limits for a 1-unit property in most areas is $647,200, which can again go up based on the number of units and the area in which you live.
FHA And Conventional Loan Property Standards
When deciding between an FHA or conventional loan, it’s important to consider what you’ll be using your property for.
FHA Loan Property Standards
To qualify for an FHA loan, the property you buy must act as your primary residence. FHA loans aren’t available for second homes or investment properties. FHA loans also have stricter appraisal standards.
Conventional Loan Property Standards
Unlike FHA loans, a conventional loan can be used to purchase a secondary home like a vacation home or investment property.
Conventional Loan Vs. FHA Interest Rates
FHA Mortgage Rates
The decreased risk for the lender generally means competitive interest rates for an FHA loan borrower.
Conventional Mortgage Rates
Conventional loans typically come with fixed or adjustable interest rates, with the option to refinance later if you qualify. A higher credit score will yield you a lower interest rate.
The FHA Streamline Refinance Program
This refinance option allows you to lower your monthly payments or interest rate faster because it doesn’t require a complete credit check or income verification. Often, an appraisal is not required.
The FHA Streamline refinance doesn’t allow you to roll closing costs into the new mortgage amount.
The Bottom Line: Choosing Between An FHA Loan Vs. Conventional Loan Is A Personal Choice
If you meet the requirements for both an FHA loan and a conventional loan, take time to compare total costs. You can use our mortgage loan calculator to help see which loan will better serve your financial needs.