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FHA vs Conventional Loan: Which Is Better For Homebuyers?

FHA vs Conventional Loan: Which Is Better For Homebuyers?

Both FHA and conventional loans can help you buy a home. And often, the terms are surprisingly similar.

Still, one will work better for some situations. Here’s how to decide between the two.

What is an FHA Loan Versus a Conventional Loan?

As a new (or even experienced) homebuyer, you might wonder how FHA and conventional loans are different.

There’s one fundamental difference between the two:

  • Conventional loans: The lender is not insured by the government against borrower default.
  • FHA loans: The lender is insured by the government against borrower default.

It’s really that simple. Because of this difference, lenders will approve FHA loans at drastically more lenient terms than they will conventional loans.

This is probably why some people call FHA loans “subprime” or "low-credit home loans." They are not subprime, and plenty of high-credit homebuyers use them, too.

The only question you should be concerned about is, which one is better for you?

Which Is Better? FHA or Conventional?

The bottom line: Comparing FHA and conventional loan features reveals that FHA wins out by a close margin.

  • FHA Loans: Wins 7 out of 12 categories
  • Conventional Loans: Wins 5 out of 12 categories

That being said, there are dozens of other factors that could affect which loan type you choose. Here’s a short but likely incomplete answer.

FHA loan: Better for buyers with lower credit, higher debt-to-income ratios, and less than 5% down.
Conventional loan: Better for buyers with excellent credit, low debt-to-income levels, and more than 5% down.

However, this over-simplification breaks apart quickly. High-credit buyers choose FHA and low-credit buyers choose conventional all the time. Let’s dive deeper.

FHA vs Conventional Fast Facts

FHA

Conventional

Down Payment

3.5%

3%

Credit Score

580

620

Debt-to-income ratio

56.99%

43-45%

Loan limits

$498,257

$766,550

Upfront Mortgage Insurance

1.75% of loan amount

None

Monthly Mortgage Insurance

$46/mo for each $100k borrowed

$40-$125 per month for each $100k borrowed

Interest Rates

Lower than conventional for lower-credit borrowers

Similar to FHA for higher-credit borrowers

Lenders

Most lenders offer FHA

Most lenders offer conventional

Is It Easier to Qualify for FHA or Conventional?

Winner: FHA

It is generally easier to qualify for FHA. In fact, that’s why the program was created in 1934. Its sole purpose to this day is to provide homeownership opportunities for those who can’t qualify for a conventional loan.

Those with lower credit scores, a bankruptcy in the past, or lower income will qualify for FHA much more easily.

However, plenty of people who could qualify for a conventional loan might still choose FHA. This is because monthly costs may be lower with FHA if you have a small down payment.

Credit Score Minimums

Winner: FHA

The minimum credit score for FHA is:

  • 500 with 10% down

  • 580 with 3.5% down

The minimum credit score for conventional is 620.

Keep in mind that lenders could require higher scores. For instance, some lenders may require a 620 minimum score for FHA and 660 for conventional. If your application is denied with one lender, try another.

How Your Credit Score Affects Cost

Winner: FHA

Perhaps the biggest driver of your decision to use FHA or conventional will be your credit score.

This is for two reasons:

  1. Conventional loans require higher rates for lower credit scores.

  2. Conventional mortgage insurance is much more expensive than FHA mortgage insurance for those with lower credit.

So as a homebuyer with 3-5% down and a credit score below about 680, your first job is to compare your rate and monthly payment with FHA vs. conventional.

That being said, there’s a huge change to conventional recently: First-time buyers with lower to average incomes get all those low credit score rate add-ons waived.

Still, FHA might come out on top except for the highest-credit borrowers.

Profile: First-Time Buyer, 660 Score

FHA

Conventional (≤100% median income)

Conventional (>100% median income)

Home price

$350,000

$350,000

$350,000

Down payment

3.5%

3%

3%

Example rate*

6.375%

6.5%

6.75%

Principal and interest payment*

$2,107

$2,146

$2,202

Mortgage Insurance**

$157

$435

$435

Taxes, insurance, HOA

$375

$375

$375

Total payment*

$2,639

$2,956

$3,012

*Rates and payments are for example purposes only and may not be available. Not a quote or commitment to lend. **Mortgage insurance rates from HUD and MGIC.

In the above example, the homebuyer could potentially qualify for a conventional loan. But she will likely opt for FHA when she realizes conventional will cost $300-$400 more per month.

Conventional vs FHA Down Payment

Winner: Conventional (with a caveat)

The minimum down payment for an FHA loan is 3.5% while conventional requires 3% down.

A buyer might assume that a 3% down conventional loan is better, but that down payment level comes with some requirements that many buyers won't meet.

Most 3% down conventional loans come with income limits. For instance, the Fannie Mae HomeReady loan requires you to make 80% of your area’s median income. Freddie Mac’s Home Possible has the same requirement. Only Freddie Mac’s HomeOne loan removes income limits.

Additionally, conventional loans are much harder to qualify for and come with much higher rates when you make the minimum down payment.

Lastly, conventional mortgage insurance is higher when you put 3% down. According to mortgage insurance provider MGIC, a borrower will pay about $60 more per month on a $350,000 loan when putting 3% down instead of 5%.

FHA offers easier approval plus low, standardized mortgage insurance – all for just 0.5% in additional down payment - just $1,750 more down on a $350,000 loan.

Are closing costs different for FHA vs conventional?

The down payment isn’t the only cost when buying a home. There are also closing costs, which are third-party fees that equal about 2-5% of the home’s price.

FHA and conventional closing costs are not noticeably different. They both require similar-priced appraisals, and you’ll pay the exact same amount for your credit report, title report, escrow services, and most other fees.

However, this is one big upfront cost difference: mortgage insurance.

Upfront Mortgage Insurance

Winner: Conventional

The biggest cost difference between FHA and conventional is mortgage insurance. You’ll probably pay more monthly for conventional and more upfront with FHA.

Conventional loans only require monthly mortgage insurance, often called Private Mortgage Insurance or PMI.

FHA loans, on the other hand, require upfront and monthly mortgage insurance (FHA’s “brand” of mortgage insurance is called Mortgage Insurance Premium or MIP). The upfront FHA MIP is 1.75% of the loan amount. Upfront MIP can be rolled into the loan, and most buyers choose to do just that. This increases the initial loan amount.

Upfront Mortgage Insurance Comparison: Conventional vs FHA, $350,000 home

Conventional

FHA

Home Price

$350,000

$350,000

Down Payment

3%

3.5%

Base Loan

$339,500

$337,750

Upfront Mortgage Insurance

$0

$5,911

Final Loan Amount

$339,500

$343,661

Monthly Mortgage Insurance

Winner: FHA

However, that’s not where the story ends. Though FHA requires upfront MIP, FHA mortgage insurance is often less expensive monthly.

Monthly Mortgage Insurance Comparison: Conventional vs FHA, $350,000 home

Conventional

FHA

Final Loan After Upfront Mortgage Insurance (if applicable)

$339,500

$343,661

Monthly Mortgage Insurance Rate

0.87% per year*

0.55% per year

Monthly Mortgage Insurance

$246

$157

Total Mortgage Insurance Cost over 5 Years Including Upfront Mortgage Insurance (if applicable)

$14,760

$15,331

*Conventional PMI rate from MGIC, 3% down 720 credit score

Despite the upfront mortgage insurance premium, FHA does not cost much more over the first five years than conventional.

Two reasons to choose conventional mortgage insurance

  1. You will sell or refinance in the next two or three years. Your FHA upfront mortgage insurance is non-refundable unless you refinance into another FHA loan, in which case you only get a portion back.

  2. Conventional mortgage insurance is cancelable when you reach 20% equity. You pay FHA mortgage insurance as long as you have the loan.

Income and Debt-To-Income Ratios

Winner: FHA

Back to qualification standards, which is more lenient about debt and income? FHA or conventional?

FHA is the hands-down winner here. It allows a debt-to-income ratio of 56%, meaning up to 56% of your gross income can be used for your housing cost plus all other debt payments.

For instance, if your income were $10,000 per month gross, you could be approved for up to $5,600 per month on all debts plus your house payment, assuming a strong file.

This is why FHA is a favorite of those with high student loan payments, large car payments, or have lower income.

Conventional is not so lenient. Even in the most “stretched” scenarios, conventional loans allow a maximum of a 50% debt-to-income ratio. However, most people will be limited to 43%.

Employment History

Winner: FHA

FHA is quite lenient about your employment history. If you’re a seasonal worker, have been working off and on, or switched careers in the past two years, FHA is your best bet.

Additionally, FHA does allow some applicants to be approved after just one year of self-employment.

Conventional loans require you to have two years working in your field or equivalent schooling and tougher requirements for those who have been self-employed between 12 and 24 months.

FHA vs Conventional Loan Interest Rates

Winner: FHA

Generally, FHA rates are better.

Remember that these loans are explicitly insured by the federal government. This backing reduces risk and allows lenders to issue loans at lower rates.

And the difference is even more stark if you have lower credit. Your FHA mortgage rate can be 0.50% lower than conventional – or more – if you have a lower credit score.

However, rates could be very similar for first-time homebuyers at or below 100% of their area median income. Fannie Mae and Freddie Mac waive extra fees for lower credit scores for these borrowers.

It’s always worth running both scenarios with your chosen lender. But don’t be surprised if your FHA rate is much lower than your conventional quote.

Loan Limits

Winner: Conventional

If you need a higher loan amount, choose conventional.

For a 1-unit home, the conventional loan limit for most of the country is $766,550 for 2024. In high-cost areas, the 1-unit loan limit is up to $1,089,300.

FHA is not so generous. In most areas of the country, loans max out at $498,257 for a 1-unit home. High-cost areas match conventional loans.

Standard limit

High-cost limit

FHA

$498,257

$1,149,825

Conventional

$766,550

$1,149,825

Property Requirements

Winner: Conventional

Some buyers choose conventional because they want more flexibility in the properties they can buy.

Both FHA and conventional loans require the property to be in relatively good shape. However, FHA has stronger property requirements.

If you’re looking for fixer-uppers, it may be worth choosing conventional.

Why do home sellers and Realtors prefer conventional over FHA?

Winner: Conventional

It’s the truth: home sellers prefer loan offers using conventional financing. How do they know? On the first page of the purchase contract, it shows what type of financing the buyer is using.

Many Realtors and home sellers perceive FHA as being a weaker offer. This is because it’s more likely (although not always the fact) that the buyer has a lower credit score and higher debt-to-income ratios.

Sellers also worry that the appraiser will require repairs to meet FHA property standards. In reality, FHA is not that much more strict than conventional. The perception can still cause a seller to reject your offer.

However, a conventional loan with 3% down does not look that much better to a seller than an FHA loan.

FHA Loan Pros and Cons

Following are FHA and conventional loan pros and cons.

FHA pros

  • Lower credit score minimums

  • Low down payment

  • No income limits

  • You don’t have to be a first-time buyer

  • Lower interest rates than conventional

  • Higher debt-to-income ratio limits

  • More forgiving about employment history

  • Cheaper monthly mortgage insurance than conventional

FHA cons

  • Upfront mortgage insurance

  • Monthly mortgage insurance remains for the life of the loan

  • Lower loan limits than conventional

  • Sellers often won’t accept FHA offers

  • Stricter property requirements

Conventional Loan Pros and Cons

Conventional pros

  • No upfront mortgage insurance

  • Monthly mortgage insurance is cancelable

  • Higher loan limits

  • Offers look better to sellers

  • More lenient property requirements than FHA

  • Risk-based fees waived for first-time buyers with median incomes

Conventional cons

  • Higher credit scores required

  • 3% down often comes with income limits and first-time buyer requirements

  • Higher rates for lower credit scores

  • Restrictive debt-to-income ratios

  • Solid 2-year employment history required

Is FHA or Conventional Better for First-Time Homebuyers?

In 2018 (the most recent data available) 27% of first-time buyers chose FHA, while 44% chose a conventional loan from Fannie Mae or Freddie Mac (the “GSEs”) says the Consumer Finance Protection Bureau.

This doesn’t mean conventional is “better,” but for a certain segment of first-time buyers, it proved to be the better choice in immediate cost or for their long-term goals.

But for 27% of first-time buyers, FHA is the clear winner. This could be due to

  • Needing a low down payment without income limits

  • Having lower credit or income

  • Needing higher debt-to-income ratios in expensive markets

  • Wanting lower monthly costs than conventional could provide

  • Other reasons

Choosing FHA or conventional as a first-time buyer requires a comparison of the two programs with a lender, and examination of your long-term goals.

FHA vs Conventional FAQ

Do you have to be a first-time homebuyer to use FHA?

No. Both first-time and repeat buyers can use the program.

Do FHA and conventional loans come with income limits?

There are no income limits for FHA, but most 3%-down conventional loans require you to make no more than 80% of your area’s median income.

Can I get approved for both FHA and conventional?

You might get approved for both loan types. In this case, examine upfront and monthly costs of each scenario to decide which one is better for you.

What is the main difference between FHA and conventional loans?

The government insures FHA loans in the case of default. Conventional loans don’t come with a government guarantee. This allows lenders to issue FHA loans at lower rates and more lenient guidelines compared to conventional.

What is the downside of an FHA loan?

FHA loans come with permanent mortgage insurance which is only cancelable by refinancing to a conventional loan. FHA also requires an upfront mortgage insurance premium. Also, home sellers are less likely to accept an offer with FHA financing.

Summary: Final Score

Tallying up the winner of each section above, here’s the final count.

  • FHA Loans: Wins 7 of 12 categories
  • Conventional Loans: Wins 5 of 12 categories

This doesn’t mean FHA loans are always better. One “pro” can mean more than all the cons. For example, you might choose conventional only to get your offer accepted in a tough market, or to be able to cancel your mortgage insurance someday.

This is why there is no better or worse when it comes to these loans. They are both good for different situations.

Which one will you choose?

About The Author:

Tim Lucas spent 11 years in the mortgage industry and now leverages that real-world knowledge to give consumers reliable, actionable advice. Tim has been featured in national publications such as Time, U.S. News, MSN, The Mortgage Reports, My Mortgage Insider, and more.

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