FHA vs. conventional loans: What’s the difference?

Key takeaways

• FHA loans and conventional loans are both issued by private lenders, but FHA loans are insured by the federal government, and conventional loans are not.

• Due to their federal backing, FHA loans have more lenient criteria, making them better suited for borrowers with lower credit scores or who don’t have much money for a down payment.

• Conventional loans require a higher credit score and stronger financials, but also come with lower costs, less-stringent home appraisals and cancellable mortgage insurance.

If you’re getting ready to buy a house, you have a lot of decisions to make. The same way that you can explore types of properties, you can (and should) explore different types of mortgages.

The two most popular kinds of mortgages are conventional loans and FHA loans. They have substantial differences in loan limits, mortgage insurance terms and conditions, and debt-to-income maximum ratios.

More on all that below — and how to choose when considering an FHA vs. a conventional loan.

Comparing FHA and conventional loans

Both FHA loans and conventional loans are mortgages originated by and issued through private lenders that allow you to finance the purchase of a home.

Conventional loans are what most people think of when they envision a mortgage. They are available through the majority of lenders in the U.S. — including banks, credit unions, savings and loan institutions and online mortgage companies — and can come in a range of terms, commonly 15 or 30 years, with a fixed or adjustable interest rate. They are not backed or guaranteed in any way by the government: The lender bears all the risk of the debt.

In contrast, FHA loans are insured by the Federal Housing Administration (FHA) and are geared toward homebuyers who might have difficulty obtaining a conventional loan. They have more flexible requirements — primarily a lower minimum credit score and a smaller down payment.

Understanding FHA loans

The FHA is a division of the U.S. Department of Housing and Urban Development. For it to insure a mortgage basically means the government will compensate the lender in case the borrower defaults on payments. In return, the lender follows the FHA’s more lenient underwriting criteria, approving borrowers with lower credit scores (in the 500s) than it might normally require, and requiring smaller down payments (usually between 3.5 and 10 percent of a home’s purchase price.)

Other than that, FHA loans work like most other mortgages, with either a fixed or adjustable interest rate and a loan term for a set number of years. FHA loans come with two term options: 15 years or 30 years. They do require you to pay mortgage insurance premiums (MIP) regardless of your down payment amount.

Understanding conventional loans

Conventional loans don’t have government backing. This means the underwriting criteria for approval are stricter, and you must have a higher credit score (at least 620) to qualify. Also, a 20 percent down payment tends to be the standard, though some lenders will allow smaller amounts. If you do put less than 20 percent down, the lender is likely to charge you private mortgage insurance until you are halfway through your loan term.

Depending on the characteristics of the loan, a conventional mortgage is either conforming or nonconforming. Often, conventional lenders sell these types of mortgages to Fannie Mae or Freddie Mac, the  secondary mortgage market-makers, after they’re funded. In order to do this, the loan has to conform to, or meet, Fannie and Freddie standards around loan size, borrower financials, and other factors. If it doesn’t, the mortgage is considered nonconforming.

FHA vs. conventional loan requirements

Credit score: FHA loan vs. conventional loan

FHA loan borrowers can qualify with a credit score as low as 500 or 580 depending on their down payment amount: as low as 500 with 10 percent down, or as low as 580 with 3.5 percent down. Conventional loans require a credit score of at least 620. If you have excellent or good credit, a conventional loan is often the better choice.

DTI ratio: FHA loan vs. conventional loan

Another FHA vs. conventional loan differentiator: the debt-to-income (DTI) ratio maximum. This ratio is the measure of all your debt (the mortgage included) relative to your monthly income. For a conforming conventional loan, the maximum DTI ratio is 43 percent. For an FHA loan, the DTI ratio can go up to 50 percent.

Down payment: FHA loan vs. conventional loan

Depending on the lender and program, some conventional loans require as little as 3 percent or 5 percent for a down payment. However, 20 percent is usually the standard amount; many lenders won’t finance more than 80 percent of the home’s price.

In contrast, small down payments are more the norm with FHA loans. If your credit score is at least 580, you can put down just 3.5 percent for an FHA loan; if your score is below 580 (but not lower than 500), you’ll be required to put down 10 percent. Here’s more on minimum down payment requirements.

Loan limits: FHA loan vs. conventional loan

Depending on your location, choosing between an FHA versus conventional loan might come down to the price of the house you want to buy.

Both types of loans have limits on the amount you can borrow. The conventional conforming loan limit, set by the Federal Housing Finance Agency each year, starts at $766,550 in 2024 and goes up to $1,149,825 in more costly housing markets. A conventional loan can exceed these limits, but at that point, it’d be considered a nonconforming jumbo loan.

The FHA loan limit is also adjusted each year, and there are different limits based on location and property type. In 2024, the FHA loan limit for a single-family home is $498,257 in most markets and goes up to $1,149,825 in higher-cost areas.

Mortgage insurance: FHA loan vs. conventional loan

If you don’t have 20 percent of the home’s purchase price for a down payment, you’ll be required to pay for mortgage insurance whether you’re getting a conventional or FHA loan. Both premiums are typically paid via your monthly mortgage payment.

FHA mortgage insurance (MIP) includes an upfront premium equal to 1.75 percent of the amount you’re borrowing. Then, you’ll pay an annual premium, which is determined by the size of your down payment, how much you borrowed and the length of the loan (15 years versus 30 years).

Aside from differences in premium structure, conventional loan borrowers don’t have to pay mortgage insurance forever — it can be canceled halfway through a loan term, or once the borrower achieves 20 percent equity (outright ownership) in the home. You can get to this threshold by following your repayment schedule to pay down the loan balance, making extra payments, or refinancing or getting a new appraisal if your home’s value has risen substantially.

In contrast, FHA mortgage insurance can’t be canceled unless you put at least 10 percent down (if so, it’ll end after 11 years), or you refinance to a different type of loan.

Appraisal: FHA loan vs. conventional loan

When financing your home through a conventional mortgage, your lender requires a home appraisal. They mandate this estimation of the home’s value to ensure it is worth the amount of money they’re extending to you.

Meanwhile, FHA lenders require a more thorough process relating to appraisals, including assessing value and the condition of the property to ensure it’s HUD- compliant. This can hurt your chances of buying a home, since listing agents might suggest their sellers look elsewhere given the time it takes to do an FHA appraisal.

Interest rates: FHA loan vs. conventional loan

With both types of loans, the lender sets the interest rate, determined primarily by your credit score. FHA loans sometimes have more favorable interest rates than conventional loans — but the difference is often offset by the greater number of fees, including the MIP charges, that they have. In fact, the FHA loan’s annual percentage rate (APR), which includes both the cost of the interest rate and all the fees, might actually be higher than that of a comparable conventional loan.

Should you get an FHA loan or conventional loan?

Which loan is better: FHA or conventional? To a large extent, that depends on you and your financial profile. Generally, a conventional loan is best for those with strong credit and a bigger home buying budget. If your credit score is below 620, a loan backed by the FHA might be your only option. It might also be a better deal if you can’t manage a 20 percent down payment, which — given the current $417,700 median price tag on homes — amounts to $83,540.

“The biggest difference between FHA and conventional would be the down payment. FHA rates typically are lower and more flexible for less down,” says Phil Crescenzo Jr., vice president, southeast division, for Nation One Mortgage Corporation.

For buyers who have the ability to bring a 20 percent down payment to the table, there would be far less benefit in seeking an FHA mortgage, unless they’re not able to qualify for a conventional mortgage because of either credit score issues or a previous bankruptcy, says Crescenzo. “In those cases, an FHA loan would be an option, but only if it was due to approval” problems.

Of course, the lower down payment comes at a cost: “Most FHA loans carry mortgage insurance for the duration, which is a drawback to some,” says Crescenzo. However, the premiums may be lower than those you’d incur on a conventional mortgage with less than 20 percent down,”as this cost is capped with an FHA loan.”

When to choose an FHA loan

An FHA loan is a good choice if you really want to become a homeowner now, but don’t have the strongest financials or credit history. Your credit score is at best “fair,” and you lack the ability to come up with a fifth of the home’s cost in cash. If you are buying in a standard real estate market, you don’t need a home priced over $500,000.

When to choose a conventional loan

Go for a conventional loan if your credit score is in the good range (at a minimum), your monthly debts are well under half of your income, and you can come up with a down payment of at least 20 percent, even for a home costing up to $700,000 or so. There are no blots on your credit history.

FAQ

• Do sellers prefer conventional loans over FHA loans?Sellers may prefer working with a buyer who has a conventional loan over an FHA loan because of the time it takes to conduct an FHA appraisal.
  
• Which is more costly, an FHA loan or a conventional loan?FHA loan interest rates run slightly lower than their conventional counterparts: in mid-May, for example, a 30-year fixed FHA loan for a $400,000 house was 6.8 percent, vs. 7 percent for a comparable conventional loan. However, because they carry mandatory mortgage insurance, the FHA loan’s APR often runs higher. And though the insurance premiums are lower on FHA loans, you’ll pay them for the loan’s lifetime. All told, the FHA loan will be a bit more expensive, costing in total about $30,000 more in this example.
  
• Are FHA loans only for first-time home buyers?No, FHA loans are not limited to just first-time home buyers. Those who are first-time and also repeat home buyers are able to use FHA loan programs to purchase a home. FHA loans can also be used by repeat homebuyers to refinance a loan.
  

Additional reporting by Mia Taylor