FHA vs conventional loans

Considered the two most popular types of mortgages, FHAs and conventional loans have their specific pros and cons.

Pat Howard 1600

Pat Howard

Published June 10, 2019

KEY TAKEAWAYS

  • An FHA loan is a good option if you have a low credit score and can only afford a small down payment

  • Conventional loans have higher down payments and interest, but if you put down more than 20%, you don’t have to pay for mortgage insurance, which may save you money down the line

When you’re taking out a mortgage on a home, you’ll probably be deciding between an FHA loan and a conventional loan — the two most common types of mortgages.

An FHA home loan is insured by the Federal Housing Administration (FHA) and is a good option if you have a credit score in the 500s and can only afford a small down payment. Conventional loans typically require a higher credit score and down payment, but they have a significantly less strict inspection process and may prove to be a cheaper option over the life of the loan.

But both FHA and conventional loans have a number of advantages and disadvantages — we’ll break those down for you in this guide and help you arrive at a decision that makes sense for you.

In this guide:

FHA vs conventional loans comparison

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Credit score requirements

One of the major advantages of FHA loans is if you have a low credit score, or if you filed for bankruptcy in the last year, you’ll still be able to acquire an FHA loan as long as your score is above 500.

If your score is above 580, you can qualify for a down payment as low as 3.5% the value of the home. However, if your credit score is between 500 and 580, you’ll have to make a down payment of at least 10%.

Conventional loans come in a couple different forms — conforming loans, which are subject to a number of guidelines set by government entities Fannie Mae and Freddie Mac, and nonconforming loans, which tend to be riskier and have higher interest rates.

Although certain types of nonconforming loans accept low credit scores, a standard conventional loan will generally require a credit score north of 620. The higher your credit score, the lower your offered interest rate will be.

Down payments

Another advantage of FHA loans is they only require a 3.5% down payment; if you’re in a cash bind, FHA loans are a good option.

Most conventional loans require a down payment of at least 10%, although certain conforming loans through Fannie Mae accept down payments as low as 3% if you’re a first-time homebuyer and meet the program’s income qualifications. Fannie Mae also has a 5% down payment program for previous homeowners if you meet certain income requirements.

Mortgage insurance premiums

Mortgage insurance protects your lender’s investment in the event you stop paying your mortgage or you foreclose on your home. You pay your mortgage insurance premiums (MIP) as part of your monthly mortgage payment, and in the case of FHA loans, you pay a sizeable chunk of your premiums up front.

One of the major downsides of FHA loans is if your down payment is less than 10%, you’re stuck paying MIP throughout the life of the loan. That puts prospective FHA loan borrowers in a bind — it’s an appealing option because of the low down payment, but putting down a small amount could leave borrowers with a more expensive mortgage down the road because of mortgage insurance.

If your down payment is 10% or more, you’re not required to pay MIP throughout the life of the mortgage, but you’ll still have to pay 11 years of premiums before they no longer appear on your bill.

Furthermore, with FHA loans you’re required to pay 1.75% of your loan amount up front as part of your mortgage closing costs. That means if your loan was $180,000, you’d have an upfront payment of $3,150 just in MIP. From there, your annual MIP will be anywhere from 0.45% to 1.05% of your remaining mortgage amount for that year.

Conventional loans are slightly more forgiving when it comes to mortgage insurance. In fact, if your loan-to-value ratio [LTV] (your loan amount as a proportion of the home’s value) is greater than 80% at the outset of the loan, you won’t have to pay private mortgage insurance (PMI) at all. If your down payment is less than 20%, your lender will most likely require PMI, but it’s automatically canceled when your amortized payments reach 78% LTV.

Additionally, you typically don’t need to pay for PMI as part of your closing costs. Even though you may have had higher interest rates and down payment with a conventional loan, the amount you’ll save in mortgage insurance could save you big money in the long run.

Annual PMI costs will vary by lender, but it’s usually anywhere from 0.5% to 1% of your remaining mortgage amount for that given year.

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Property expectations

If you’re the type who likes to invest in fixer-uppers and flip homes once they’ve increased in value, a standard FHA loan isn’t your best bet. In fact, you won’t be eligible for FHA loans unless the mortgage is for your primary home.

Conventional loans have more relaxed standards in that sense. If you’re using the home as a vacation home, a rental property, or you have extensive renovations planned and don’t plan to live at the property, a conventional loan is your best bet.

However, keep in mind that the FHA does offer certain types of loans — like FHA construction loans or 203(k) rehabilitation mortgages — that allow the same benefits of FHA loans if you’re planning to build a new home or renovate.

Closing costs

You generally pay higher closing costs with FHA loans, as you need to pay for MIPs in addition to application fees, origination fees, attorney fees, and homeowners insurance. In fact, if you live in a FEMA-designated Special Flood Hazard Area (SFHA), FHA loans will also require that you get flood insurance, and you’ll have to pay for that up front as well.

However, FHA loans do allow for “interested parties” — like real estate agents, sellers, and brokers — to pay for closing costs up to 6% of the loan amount. Under conventional loan terms, interested parties can only pay up to 3% of the loan amount. So the net amount you pay in closing costs may be less with FHA loans in some cases.

Debt-to-income ratio

In the past, you could only qualify for FHA loans if you had a less favorable debt-to-income (DTI) ratio (your total debt like student loans, car loans, or other mortgage payments as a percentage of your income). But as of 2019, Fannie Mae is allowing lenders to offer conventional loans to borrowers with a DTI ratio as high as 50%.

As of 2019, the qualifying debt-to-income ratio for FHA loans was 43%, but they’ll accept DTIs as high as 50% in certain cases, like if you have residual income or you agree to make a minimal increase in monthly mortgage payments.

Inspection process

In order to qualify for an FHA loan, a home must go through a number of property inspections that you simply aren’t subject to with conventional loans. If your home is in need of extensive repairs or isn’t up to FHA property standards, you won’t qualify for a standard FHA loan.

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