Buying a home can be an exciting experience. However, before you start shopping for the perfect place to live, it’s good to understand what kind mortgage that you will use to finance your purchase—this can affect your potential interest rateminimum down paymentand more.
The two most popular home loan programs, especially for first home buyersare FHA loans and conventional loans. Both types of mortgages have advantages and disadvantages. 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 mortgage backed by the government. The Federal Housing Administration—a division of the US 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 will need to find an FHA lender.
Because the federal government backs FHA loans, there is less risk to the lender if the buyer defaults. Therefore, the requirements are usually easier to meet when it comes to FHA loans—making them an attractive option for borrowers with poor credit scores as well as home buyers who may be struggling 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 is available without any backing or insurance from the federal government. If you qualify, 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 in order to qualify for this type of mortgage. In some cases, you may need a slightly larger down payment to be able to get a conventional loan as well.
Although conventional loans are not backed by the government, certain conventional loans must follow rules set by the Federal Housing Finance Agency (FHFA), including borrowing limits. These are called conforming loans. But non-conforming loans, including jumbo loansthey do not have to follow FHFA rules.
Learn more: What credit do you need to buy a home?
Key Differences Between FHA and Conventional Home Loans
FHA loans and conventional loans have their own requirements that you must meet to qualify for financing. In general, FHA loans have less approval criteria compared to conventional loans when it comes to factors such as credit scores and advance payment. At the same time, credit limits for 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 requirements
Many FHA lenders will work with borrowers who have FICO score of 580 or more. Some lenders may be willing to accept applicants with a credit score as low as 500—but then the borrower will need to put down at least 10% down instead of the usual FHA loan minimum of 3.5%.
For conventional loans, some lenders may approve borrowers with a FICO score of 620 or higher. However, other lenders may require a minimum score of at least 660.
Down payment
It is 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 accepting borrowers with lower credit scores (eg in the 500 to 579 range) can be expected to require a 10% down payment instead.
For comparison, there are conventional low down payment loan options first-time home buyers with a down payment of just 3%. Otherwise, the minimum down payment requirement for a conventional mortgage could range between 5% and 15%, depending on the details of your loan. And if you want to avoid paying private mortgage insuranceyou will need to give your lender a down payment of 20% or more.
Learn more: What is down payment assistance and how do you get it?
Interest rates
FHA loans can be attractive mortgage interest compared to conventional loans because the state support for the loan reduces the risk for the lender. But the rate a lender offers you for any type of mortgage can vary depending on the market and the details of your loan.
Risk factors such as your creditworthiness, debt-to-income ratio (DTI), down payment, loan term and whether you have a fixed rate or adjustable rate mortgage may also come into play.
Loan restrictions
The FHA sets new loan limits each year that determine the maximum amount you can borrow using this loan program. If you are interested in using an FHA loan to buy a home, it is important to know the FHA loan limit for your area. Loan limits vary by county, and you can visit HUD website to check the FHA mortgage limit for different locations.
For 2024, the above FHA loan limits are as follows.
- Low-cost districts: $498,257
- High cost counties: $1,149,825
Conforming conventional loans also have loan limits, but in many areas they are higher than FHA loan limits. If you are interested in a more expensive property, a conventional loan may be better suited to your situation in some locations. For 2024, the adjusted common credit limit range is between $766,550 and $1,149,825 (in high-cost areas).
Loan limits for conforming conventional loans stem from the Federal Housing Finance Agency’s (FHFA) efforts to maintain stability in the housing market.
Fannie Mae and Freddie Mac—called government-sponsored enterprises, or GSEs—set requirements for the mortgages (ie, conventional loans) they buy from lenders. The FHFA regulates the GSEs and places credit limits on conforming loans to prevent over-borrowing and foreclosures and to help the GSEs avoid financing unaffordable mortgages that may pose too much risk.
Note that borrowers can also apply for nonconforming conventional loans, called jumbo loans, if they need to borrow above the available loan limits. However, jumbo loans tend to have stricter qualification standards because a larger loan size can increase the risk to the lender.
Mortgage insurance
Mortgage insurance is a policy that provides protection to the lender if he defaults on his home loan. With an FHA loan, your lender will require you to pay two types of mortgage insurance – upfront and annually.
The upfront mortgage insurance premium (UFMIP) for an FHA loan is typically 1.75% of the principal amount of the loan. You can add this cost to the loan amount if you don’t have the funds to pay in advance. 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 may also require private mortgage insurance (PMI) to protect the lender’s investment. But if you are able to put a 20% down payment on your regular loan, you should be able to avoid this extra cost.
PMI premiums can vary based on several factors. However, Freddie Mac estimates that PMI can cost between $30 and $150 per month for every $100,000 you borrow.
To take away
FHA loans and conventional loans represent two different paths to home ownership. The best home loan option for your situation will depend on a number of factors, including your creditworthiness, your ability to save for a down payment and how much money you need to borrow to buy your desired property.
It is important to do your own research and explore different loan options before applying for a mortgage. And you may want to consider other loan options, including VA loans and USDA loans, depending on your situation. Keep in mind that a reputable lender should also be able to give you guidance and help answer your questions.
All that said, an FHA loan may be the option you need to get into your new home—especially if you have a lower credit score that might make it difficult to get a conventional mortgage.
