Choosing the right mortgage is one of the most important decisions when buying a home. Among the most popular home loan options are FHA loans, backed by the Federal Housing Administration. These loans can be a great choice if you have poor or moderate credit and limited savings, but they also come with drawbacks.
On the other hand, conventional loans are more widely available and have more flexible terms. For borrowers with good credit and a large down payment, conventional mortgages usually offer the best rates.
🏡 Which one should you choose?
FHA loans: Best if you’re a first-time homebuyer with a credit score between 500 and 620 and you have only a small down payment.
Conventional loans: Best if you have a credit score above 620, a down payment of 5% to 20%, and you want to avoid mortgage insurance.
We’ll break down FHA loans vs. conventional loans, including what each one is, their pros and cons, and when you should choose one over the other.
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FHA vs. conventional loans: Side-by-side comparison
| FHA loan | Conventional loan | |
|---|---|---|
| Minimum credit score | 500–579 (10% down) or 580+ (3.5% down) | Usually 620+ |
| Minimum down payment | 3.5% | Usually 3% to 5% |
| Debt-to-income ratio | Up to 43% (without compensating factors) | Typically up to 50% |
| Mortgage insurance | Required for 11 years or loan term | Only required for down payments under 20% |
| Eligible properties | Primary residence | Primary, secondary, and investment |
| Loan limit | Usually lower but varies by area | Usually higher |
| Interest rates | Lower for borrowers with moderate credit | Lower for borrowers with good credit |
| Down payment gift allowed? | Entire down payment can be a gift | Varies by lender |
What are FHA loans?
FHA loans are fully backed by the Federal Housing Administration, a federal government agency. Because of this backing, they’re less risky for lenders, which means they can offer buyers more flexible terms and rates than they’d get with conventional loans.
FHA loans are designed to make buying a home possible for people who would otherwise fail to qualify for a conventional mortgage, especially first-time home buyers. Such buyers include those with a low credit score, limited savings, and less stable incomes.
FHA loans have some unique features compared to conventional loans. For one, they tend to have lower limits, which vary based on location. Borrowers must also pay for mortgage insurance premiums (MIP) both upfront and annually, often for the life of the loan.
There are streamlined refinancing options with FHA loans as well. Plus, FHA loans are assumable, meaning when you sell your home in the future, the buyer can take over your loan.
What are conventional loans?
Conventional loans are mortgages backed by private lenders, such as a bank or credit union. These loans are often sold to Fannie Mae and Freddie Mac to maintain a healthy mortgage market. Because of this, most conventional loans must meet requirements set by these companies, such as loan limits and credit requirements.
Conventional loans are more flexible than FHA loans and can be adapted to specific borrower needs. For example, conventional loans can be used to finance the purchase of a primary, secondary, or investment property, while FHA loans can only be used for a primary residence.
For borrowers with good credit (typically over 620), conventional loans offer good interest rates and more favorable terms. If you’re able to save 20% for a down payment, you can also avoid paying for private mortgage insurance (PMI). By contrast, FHA loans usually have insurance requirements for the life of the loan.
FHA loan vs. conventional loan: Pros and cons
FHA loans
Pros
- Lower credit score: FHA loans are open to borrowers with credit scores as low as 500, although you’ll get better terms if your score is over 580. Those credit scores are usually considered too low for conventional loans.
- Smaller down payment: With an FHA loan, you can qualify with a down payment as low as 3.5% (so long as your credit score is above 580). Even with a credit score of 500 to 579, you can qualify with a 10% down payment.
- Higher debt-to-income: In some cases, you can qualify for an FHA loan with a debt-to-income (DTI) ratio of up to 43% (without compensating factors). Conventional loans have a DTI limit closer to 50%.
- Streamlined refinancing: FHA loans are easy to refinance and don’t always require a new appraisal or as much documentation as a conventional loan.
Cons
- Mortgage insurance premium: You’ll usually have to pay an MIP both upfront and annually for the life of the loan, unless you refinance to a different type of loan. If you have a down payment of at least 10%, the MIP drops after 11 years.
- Lower loan limits: FHA loans have lower limits than conventional loans, which may limit your buying options. The specific limits vary by area.[1]
- Property eligibility: FHA loans can only be used for your primary residence. Plus, you’ll need to pass an FHA appraisal for safety and habitability, which makes buying fixer-uppers more difficult.
- Lender availability: While FHA loans are offered through most major lenders, smaller lenders may not offer them.
Conventional loans
Pros
- Removable insurance premium: There’s no upfront mortgage insurance premium with conventional loans, and private mortgage insurance (PMI) is only required for down payments of less than 20%.
- Higher loan limits: Lenders are able to offer higher loan limits for borrowers with good credit, including jumbo mortgages for high-end properties.
- Potential for lower rates: If you have excellent credit and a large down payment, it’s easier to negotiate a lower interest rate on a conventional mortgage. This can lower the overall cost to buy a house
- More eligible properties: Unlike FHA loans, conventional loans aren’t limited to just primary residences. You can use them for a second home or investment property, including fixer-uppers.
Cons
- Higher credit requirements: Conventional loans usually require a credit score of at least 620, although you’ll get the best rates and terms if your score is above 720.
- Larger down payment: While you can get a conventional loan with a small down payment, the best terms are reserved for down payments of 10% to 20%.
- Income stability: Lenders usually require more proof of a stable income to qualify for a conventional home loan, which can make getting approved harder for self-employed borrowers.
- Lower debt-to-income: Conventional loans often require a DTI of under 50%, making them a difficult option if you have a high debt load, such as from student loans.
How FHA loans work
With an FHA loan, you must work with an FHA-approved lender (most major lenders qualify). You’ll then have to pass an FHA appraisal, which is more thorough than an appraisal for a conventional loan. Because it focuses on safety and habitability, the appraisal can delay closing and may necessitate repairs.
Loan approval may be delayed if the home requires repairs. Some common issues that can delay approval include lead paint, broken windows, and electrical and plumbing problems.
FHA mortgage requirements can be either more or less complex depending on your situation. While FHA loans often require more income documentation, there’s more flexibility for proving income from non-traditional sources, such as overtime and bonuses.
FHA loans also require a mortgage insurance premium of 1.75% to be paid upfront. While this premium can be rolled into your total loan amount, doing so will increase your loan costs.
How conventional loans work
You’ll have more options when looking for conventional loans since you’re not restricted to FHA-approved lenders. As a result, you may be able to find better rates and terms, especially with a higher credit score.
Like FHA loans, an appraisal is a necessary step for buying a home with a conventional mortgage. However, appraisals for conventional loans are more focused on market value rather than habitability, so they’re less likely to cause delays at closing.
Getting approved for a conventional loan can be faster or slower depending on your situation. If you have good credit, a stable income, and substantial assets, lenders can be very flexible and streamline your mortgage approval. However, if your credit is a bit lower or your income comes primarily from non-traditional sources, the process may take longer.
FHA vs. conventional loan: Which is right for you?
FHA loans are a better option if you have substantial debt, low or moderate credit, and limited savings. This loan option is also more suitable for those with an irregular income, such as if you’re buying a house at 65 years or older or you’re working freelance.
For example, recent college graduates with substantial student debt and who are just starting in the workforce may have less ability to save for a down payment. Combined with a low credit score, such borrowers would have difficulty qualifying for a conventional loan and should instead opt for an FHA loan.
However, if you have a credit rating above 620 and you’ve saved around 10–20% for a down payment, a conventional loan will likely get you a better rate. Also, if you’re trying to buy a property in a high-cost area or you want a second home or investment property, conventional loans are more suitable.
Whichever loan option you choose, you’ll want to make sure you’re prepared for every step of the home-buying journey. Clever’s licensed experts are available to answer your real estate–related questions and connect you with top-rate local real estate agents.
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