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Conventional Loan Vs. FHA: What’s The Difference?

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Published on December 3, 2020
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Because conventional and FHA loans are two of the most popular loan options, you’ll likely come across these terms as you prepare to buy a home or refinance your mortgage. Let’s compare the two and do a deeper dive into both to help you decide which loan is right for you.

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 mortgage insurance on loans made by FHA-approved lenders, protecting them from the risk of borrower default.

What Is A Conventional Loan?

Conventional loans are the most common in the mortgage industry. They’re funded by private financial lenders and then sold to government-sponsored enterprises like Fannie Mae and Freddie Mac.

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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. Your level of credit informs the lender whether or not you’ll be at risk of mortgage default

FHA Loans Required Credit Score

Because lenders are 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.

Conventional Loans Required Credit Score

Conventional loans have stricter requirements than FHA loans. You’ll need a higher credit score – a minimum of 620 – and a lower debt-to-income ratio (DTI) to qualify for a conventional loan than you would with an FHA loan.

Mortgage Insurance

Mortgage insurance is an insurance policy that protects the lender if the borrower is unable to continue making payments. 

FHA Loans And Mortgage Insurance

To offset a lower required credit score, FHA loans will typically 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 you can remove it.

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. However, you can request to remove PMI when you have 20% equity in the home. Once you’ve reached 22% home equity, PMI is often removed from your mortgage payment automatically.

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, 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. 

Loan Limits

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. 

Conventional Loan Limits

Conventional loans 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.

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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.

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.

Interest Rates

Your mortgage rates will largely depend upon the factors discussed above, as well as your choice between an adjustable rate mortgage (ARM) or a fixed-rate one.

FHA Mortgage Rates

The decreased risk for the lender generally means lower interest rates for an FHA loan borrower. 

Conventional Mortgage Rates

Conventional loans typically come with fixed interest rates, with the option to refinance later. A higher credit score will yield you a lower interest rate.

The FHA Streamline Refinance Program

FHA loans have another advantage: the FHA Streamline program allows you to refinance an FHA loan without some of the costs or steps needed for other types of refinances.

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 Difference Between FHA And Conventional Loans: A Summary

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.

To put it simply, FHA loans are generally easier to qualify for, and they allow for lower credit scores, while conventional loans may not require mortgage insurance with a large enough down payment. Choosing the best loan option for you depends on your personal financial situation.

FHA Loan Vs. Conventional Loan: 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.

If you still have questions, we’re here to help! Speak with a Home Loan Expert or call us at (800) 769-6133.

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Call our Home Loans Experts at (800) 251-9080 to begin your mortgage application, or apply online to review your loan options.

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