When you’re planning to buy a home, one of the first and most important decisions you’ll face is choosing the right type of mortgage loan. Two of the most common options available are FHA loans and conventional loans. Each comes with its own set of benefits, eligibility requirements, and costs. Understanding the difference between FHA and conventional loans can make a huge impact on your long-term financial plans and your ability to qualify for the home you want. Both loan types serve different types of borrowers and are structured in ways that influence your down payment, mortgage insurance, and credit score requirements.
What Is an FHA Loan?
Definition and Purpose
An FHA loan is a mortgage insured by the Federal Housing Administration, a government agency that helps make homeownership more accessible for first-time buyers and those with limited credit history. Because these loans are backed by the government, lenders are more willing to accept lower credit scores and smaller down payments.
Key Features of FHA Loans
- Minimum credit score requirement of 580 with a 3.5% down payment
- Higher debt-to-income ratio allowances
- Mandatory mortgage insurance premiums (MIP)
- Loan limits set by geographic location
- Must be used for a primary residence
What Is a Conventional Loan?
Definition and Purpose
A conventional loan is a mortgage that is not insured by a government agency. These loans are offered by private lenders and typically conform to standards set by Fannie Mae and Freddie Mac. Borrowers with strong credit, solid income, and a larger down payment are more likely to qualify for conventional loans, which can often result in lower overall costs compared to FHA loans.
Key Features of Conventional Loans
- Minimum credit score of 620 (often higher for better rates)
- Down payments as low as 3%, though 20% is common to avoid private mortgage insurance (PMI)
- PMI can be canceled once you reach 20% equity
- No upfront mortgage insurance required
- Can be used for primary, secondary, or investment properties
Main Differences Between FHA and Conventional Loans
1. Down Payment Requirements
One of the biggest differences between FHA and conventional loans is the required down payment. FHA loans require as little as 3.5% down for borrowers with a credit score of 580 or higher. Those with scores between 500 and 579 may still qualify with a 10% down payment. On the other hand, conventional loans may require as little as 3% down, but borrowers usually need a higher credit score to qualify. A 20% down payment eliminates the need for PMI on conventional loans, potentially saving money in the long term.
2. Credit Score Criteria
FHA loans are known for their lenient credit score requirements. A score of 580 is typically enough to qualify for the minimum down payment. In contrast, conventional loans are more credit-sensitive. Borrowers usually need a score of at least 620, and higher scores help secure better interest rates and terms.
3. Mortgage Insurance
Both loan types require mortgage insurance under certain conditions, but how that insurance is applied differs significantly. FHA loans require both an upfront mortgage insurance premium (UFMIP) and monthly mortgage insurance payments for the life of the loan (unless you refinance into a conventional loan). Conventional loans, on the other hand, require private mortgage insurance (PMI) only when the down payment is less than 20%. PMI on a conventional loan can be canceled once you reach 20% home equity.
4. Loan Limits
FHA and conventional loans are also subject to different loan limits. FHA limits vary by location and are typically lower than conventional limits. These caps are set to ensure the loans are used for modest homes. Conventional loans can go higher, and if the loan exceeds the conforming limit, it becomes a jumbo loan with different requirements.
5. Property Requirements
FHA loans have stricter property standards. The home must meet minimum safety and livability requirements as set by the Department of Housing and Urban Development (HUD). Appraisals for FHA loans are more comprehensive and can lead to necessary repairs before closing. Conventional loans generally have less rigid appraisal standards, making them more flexible in terms of property condition.
6. Who They’re Best For
FHA loans are ideal for:
- First-time homebuyers
- Borrowers with lower credit scores
- Those with a limited down payment
Conventional loans are better suited for:
- Borrowers with good to excellent credit
- People who can make a larger down payment
- Homebuyers purchasing secondary or investment properties
Costs Over Time
Long-Term Financial Impact
FHA loans may seem more accessible at the beginning due to the lower down payment and flexible credit requirements, but they often result in higher long-term costs because of mandatory mortgage insurance for the life of the loan. Conventional loans may be harder to qualify for initially, but they can offer savings in the long run through lower interest rates and the ability to cancel PMI.
Interest Rates
FHA loans tend to have slightly lower interest rates compared to conventional loans because of the government insurance backing. However, because FHA mortgage insurance premiums do not go away, the total borrowing cost can still be higher over time.
Flexibility and Future Refinancing
Switching Loan Types
Many borrowers start with an FHA loan and later refinance into a conventional loan once they improve their credit score or build equity. This strategy allows them to remove mortgage insurance and potentially lower their monthly payments.
Loan Assumability
FHA loans are assumable, meaning if you sell your home, the buyer can take over your loan (subject to approval). This can be an attractive feature if your existing interest rate is lower than the current market rate. Conventional loans are not typically assumable.
How to Choose Between FHA and Conventional
Evaluate Your Financial Profile
Start by reviewing your credit score, income, and how much you’ve saved for a down payment. If you have strong credit and a good down payment, a conventional loan may offer better terms and lower total costs. If your credit score is lower or your savings are limited, FHA loans may provide a more realistic path to homeownership.
Factor in Long-Term Goals
If you plan to stay in the home for a long time, consider the cumulative cost of mortgage insurance. If you intend to sell or refinance within a few years, an FHA loan may make sense. Think about your goals and how they align with each loan type’s structure.
The difference between FHA and conventional loans lies in their structure, requirements, and long-term financial impact. FHA loans offer accessibility to homeownership for those with less-than-perfect credit or limited savings, while conventional loans reward stronger financial profiles with lower costs and more flexibility. Choosing the right loan involves evaluating your current financial standing and your future homeownership goals. By understanding these key differences, you can make a well-informed decision that sets you up for success in your home-buying journey.