FHA loan vs. conventional loan: What homebuyers should know

Two of the most popular home loan programs, especially for first-time homebuyers, are FHA loans and conventional loans. Both types of mortgages have benefits and drawbacks. So, if you’re trying to decide whether an FHA loan or a conventional loan makes the most sense for your financial situation, the following guide will help you compare these financing options.

Learn more: Compare FHA mortgage rates today.

What is an FHA loan? 

An FHA loan is a type of government-backed mortgage. The Federal Housing Administration—a division of the U.S. Department of Housing and Urban Development (HUD)—insures these home loans, but does not issue them. If you want to apply for an FHA loan, you’ll need to find an FHA lender.   

Because the federal government backs FHA loans, there’s less risk involved for the lender if the buyer defaults. Therefore, the requirements tend to be easier to satisfy where FHA loans are concerned—making them an attractive option for borrowers with low credit scores as well as for homebuyers who may struggle to come up with a large down payment. 

Learn more: How to buy a house with bad credit.

What is a conventional loan? 

A conventional loan is a mortgage loan that’s available without any backing or insurance from the federal government. If eligible, you can get these private home loans from a variety of banks, credit unions, and other lenders. But you usually need at least a fair credit score to qualify for this type of mortgage. In some cases, you may need a slightly larger down payment to be eligible for a conventional loan as well. 

Even though conventional loans don’t receive government backing, certain conventional loans have to follow rules that the Federal Housing Financing Agency (FHFA) sets, including borrowing limits. These are called conforming loans. But non-conforming loans, including jumbo loans, don’t have to follow FHFA rules.  

Learn more: What credit score do you need to buy a house?

Key differences between FHA vs. conventional home loans 

FHA loans and conventional loans each have their own requirements you must meet to qualify for financing. In general, FHA loans have more forgiving approval criteria compared to conventional loans when it comes to factors like credit scores and down payments. At the same time, loan limits on conventional loans can offer more flexibility depending on the amount you want to borrow. 

Below are some of the key differences between FHA and conventional loans. 

Credit score requirements

Many FHA lenders will work with borrowers who have a FICO Score of 580 or higher. Some lenders may be willing to accept applicants with credit scores as low as 500—but in that case, the borrower will need to put up at least a 10% down payment rather than the usual FHA loan minimum of 3.5%. 

For conventional loans, some lenders may approve borrowers with a FICO Score of 620 or higher. Yet other lenders may require a minimum score of at least 660. 

Down payment

It’s possible to get an FHA home loan with a down payment as low as 3.5% if you have a FICO Score of 580 or higher. However, lenders that accept borrowers with lower credit scores (e.g. in the 500 to 579 range) can be expected to require a 10% down payment instead. 

By comparison, there are low-down payment conventional loan options for first-time home buyers with down payments as low as 3%. Otherwise, the minimum down payment requirement for a conventional mortgage could range between 5% to 15% depending on the details of your loan. And if you want to avoid paying private mortgage insurance, you’ll need to provide your lender with a down payment of 20% or more. 

Learn more: What is down payment assistance and how do you get it?

Interest rates

FHA loans may feature attractive mortgage interest rates compared with conventional loans because the government’s backing of the loan reduces the risk for the lender. But, the rate a lender offers you on either type of mortgage can vary depending on the market and the details of your loan. 

Risk factors like your credit score, debt-to-income (DTI) ratio, down payment, loan term, and whether you have a fixed-rate or adjustable-rate mortgage can also come into play. 

Loan limits

The FHA sets new loan limits each year that determine the maximum amount you can borrow using this loan program. If you’re interested in using an FHA loan to buy a home, it’s important to know the FHA loan limit for your area. Loan limits vary by county, and you can visit the HUD website to check the FHA mortgage limit for different locations. 

For 2024, FHA upper loan limits are as follows. 

• Low-cost counties: $498,257
• High-cost counties: $1,149,825

Conforming conventional loans also have loan limits, but they’re higher than FHA loan limits in many areas. If you’re interested in a higher-cost property, a conventional loan might be a better fit for your situation in some locations. For 2024, conforming conventional loan limits range are between $766,550 and $1,149,825 (in high-cost areas). 

The loan limits on conforming conventional loans stem from the efforts of the Federal Housing Finance Agency (FHFA) to maintain stability in the housing market. 

Fannie Mae and Freddie Mac—collectively called government-sponsored enterprises or GSEs—set requirements for the mortgages (i.e., conventional loans) that they purchase from lenders. The FHFA regulates the GSEs and sets loan limits on conforming loans to help prevent overborrowing and foreclosures, and help the GSEs avoid financing unaffordable mortgages that might pose too much risk.

Keep in mind that borrowers can also apply for nonconforming conventional loans, called jumbo loans, if they need to borrow above available loan limits. However, jumbo loans typically have stricter qualification standards because the larger loan size may increase the risk involved for the lender.

Mortgage insurance

Mortgage insurance is a policy that provides the lender with protection if you default on your home loan. With an FHA loan, your lender will require you to pay two types of mortgage insurance—upfront and annual. 

The upfront mortgage insurance premium (UFMIP) for an FHA loan is typically 1.75% of your base loan amount. You can add this cost into your loan amount if you don’t have the funds available to pay upfront. Annual mortgage insurance premiums (MIP) generally range between 0.45% to 1.05% of the loan amount. Your lender will split your MIP premium into 12 installments and add it on top of your monthly mortgage payment. 

Conventional loans can also require private mortgage insurance (PMI) to protect the lender’s investment. But if you’re able to provide a 20% down payment on your conventional loan, you should be able to avoid this added cost. 

PMI premiums can vary based on several factors. However, Freddie Mac estimates that PMI may cost between $30 to $150 per month for every $100,000 you borrow. 

The takeaway

FHA loans and conventional loans represent two different paths to homeownership. The best home loan option for your situation will depend on a variety of factors, including your creditworthiness, your ability to save a down payment, and how much money you need to borrow to purchase your desired property.

It’s important to do your own research and explore various loan options before you apply for a mortgage. And you may want to consider other loan alternatives as well, including VA loans and USDA loans, depending on your situation. Keep in mind that a reputable lender should also be able to provide you with guidance and help answer your questions as well.  

All that said, an FHA loan may be the option you need to get into your new home—particularly if you have a credit score on the lower end that might make it difficult to get a conventional mortgage.