May 3, 2022 by 1 Comment

FHA loans are easier to qualify for and require a lower down payment, compared to conventional loans. This makes FHA loans more affordable for lower-income borrowers or those who want to own a home but are actively working to improve their credit.

If you have a high enough credit score and a low debt-to-income ratio, you might be able to qualify for a conventional loan. 

In this article, you’ll learn everything you need to know about FHA and conventional loans, how they differ, and what benefits you can expect.

How are FHA and Conventional Mortgage Loans Different?

FHA (Federal Housing Administration) loans are backed by the government. They make homeownership possible for low to moderate-income families who may not be able to qualify for conventional loans. This may be due to poor credit, low down payment, or lack of credit history.

You may apply for an FHA loan if you have a credit score higher than 580 and can make a 3.5% down payment.

Conventional loans are not insured by the government and they are mostly geared toward borrowers who have higher credit scores and are able to make a larger down payment. You can get a conventional loan from a private lender such as a bank or credit union.

Most conventional loans require a down payment of 3-20% and a credit score of 650 or higher with a low debt-to-income ratio.

FHA vs Conventional Comparison Chart

When considering whether to apply for an FHA or conventional loan, keep these important points in mind:

  1. Because of this, lenders are able to offer mortgages up to 96.5% of the home value, meaning that a lower down payment is required.
  1. FHA loans are federally insured, meaning that the government will back the loan and protect the lender in the event you are unable to make payments. 
  1. Lenders are willing to lend money at lower interest rates than if the loan was not backed by the government which makes the monthly payment less expensive. 
  1. The approval odds are higher for FHA loans than for conventional mortgages. 

This chart will help you visualize the differences between FHA and conventional loans.

fha vs conventional loans comparison chart

If you need more context to better understand the difference between FHA and conventional loans, watch this short video from our mortgage blogger, Carter Wessman, who will walk you through the basics.

FHA vs Conventional Credit Guidelines

One of the major differences between FHA and conventional loans has to do with the credit score needed to qualify for each.

FHA loan credit score requirement 580FHA Credit Score Requirements

Since FHA loans were created specifically to provide an option to buyers with low and recovering credit scores, they have the lowest credit score requirements available. This makes FHA loans a viable option for first-time homebuyers who haven’t had the chance to build up their credit.

A credit score of 580 or over allows you to make a down payment of just 3.5%. If your credit score is between 500 and 579, you’ll need to put down at least 10%.

In most cases, homebuyers who have a credit score below 500 won’t be able to qualify. If you’re leaning toward an FHA home loan, it’s worth it to shoot for a credit that’s over 580.

conventional loan credit score requirement 620

Conventional Credit Score Requirements

Compared to FHA loans, conventional mortgage credit scores will typically need to be much higher. It’s difficult to guarantee an exact number since requirements vary from lender to lender and can also be contingent upon other financial factors.

620 is generally the lower limit of conventional credit requirements. Remember, though, that credit impacts interest rate.

While you may be able to go as low as 620 if the rest of your loan application is spotless, the best possible rates are reserved for higher credit scores. 

If your credit score is under 680, it will probably make more sense for you to opt for an FHA mortgage loan.

Are FHA Loans Better Than Conventional Loans?

Which is the better option for you will depend on your credit score – 680 or over for conventional loans and FHA loans for credit scores below 680.

FHA loans are easier to qualify for and require less of a down payment, which makes them a more affordable option for lower-income borrowers or those who want to own a home but are actively working to improve their credit. 

Interest rates are more competitive on FHA loans which means a lower interest rate with a lower monthly payment. Not having to bring a high down payment to the closing table means you can buy a home sooner rather than later.

In addition to that, conventional loans have stricter lending requirements, making them a harder and more expensive option to qualify for.

Down Payment Requirements for FHA and Conventional Loans

According to Terry Hastings, Manager of Total Mortgage’s Ridgefield branch, borrowers usually assume they need 10-20% down to buy a home but that may not be the case. 

“Many are opting to rent because they don’t know that they could buy—and probably pay less than renting. In reality, you don’t even have to put down 10% or even 5%.”

FHA Loan 3.5% Down Payment

With an FHA loan, you can put as little as 3.5% down on a house, putting the cost of buying a house more in range with the cost of a security deposit for a new rental. 

You just need to have a credit score of at least 580 and meet all other FHA guidelines.

Conventional Loan 3% Down Payment

With a conventional home loan, you can go as low as 3%—something that’s actually called a conventional 97 loan. Since a conventional 97 loan is technically a different program than a standard conventional loan, it has a few extra restrictions:

  • The loan must be a 30-year fixed-rate loan
  • The property must be a one-unit, single-family home, co-op, PUD, or condo.
  • The property will be the buyer’s primary residence
  • The buyer (or one of the buyers) can’t have owned a house in the last 3 years
  • The loan amount is at or under $453,100

Many first-time homebuyers meet these restrictions automatically, so they may not present major obstacles. For those that do, there’s still the option to put 5% down.

Private Mortgage Insurance for FHA and Conventional Loans

If you put less than 20% down using any loan except for a VA loan, you’ll have to get Private Mortgage Insurance (PMI). 

PMI protects lenders in the event that borrowers with low equity default on their loans—and the borrower gets to pick up the tab.

Conventional Loan PMI

When it comes to conventional loans, PMI is simple: make it to 20% equity, and you’re free and clear. This can either mean putting 20% down on the house initially or paying PMI until you hit 20% equity with your monthly mortgage payments. 

Your lender is legally required to drop your PMI automatically at 22%, or per your request at 20%.

FHA Loan PMI

For FHA loans, you’ll have to pay PMI for the life of the loan if you initially make a down payment of less than 10%. To get out of paying PMI, you’ll have to refinance once you build enough equity.

Another thing to keep in mind is that PMI tends to be higher for FHA loans than it is for conventional loans. This happens because FHA loans have slightly more relaxed credit and debt requirements.

IncIncome Requirements for FHA and Conventional Loans

Debt to income (DTI) ratio is another factor you’re going to need to consider when choosing conventional vs. FHA loans.

DTI is the percentage of your gross monthly income that will go toward paying off debt. Lenders use the following formula to calculate DTI, and you can too:

monthly expenses ÷ pre-tax monthly income =  DTI %

While the exact requirements can vary from lender to lender, most will require a 45% or lower DTI ratio for conventional loans.

Debt to Income Ratio Requirements for FHA Loans

With FHA home loans, lenders will be more flexible if the borrower is in otherwise good shape. In some cases, you might see DTI ratios as high as 55% accepted.

“I just did a loan this summer for a buyer who had a student loan,” Hastings said. 

”Even though the parent paid for the loan, the buyer’s ratios were too high for Fannie or Freddie. FHA approved the loan and without it, she would not have been able to buy a home. As it stands, her monthly payment is less than it would cost to rent.”

Interest Rates for FHA and Conventional Loans

fha mortgage loan interest rate

FHA loans tend to come with lower interest rates than conventional loans. For the most part, this is due to the fact that FHA borrowers have historically been less likely to pay off their mortgage early than conventional borrowers.

This makes the servicing of these loans more valuable and incentivizes banks to offer lower rates.

However, if FHA interest rates are the only factor that’s tipping you over the edge to an FHA, you might want to think again. 

The difference between the two has historically been fairly minor. Since rates vary from lender to lender anyway, the savings that come with an FHA could easily be offset by having to pay PMI for the life of the loan.

If you’re concerned with getting the lowest interest rate possible, there are other ways to get a lower rate, like opting for an Adjustable Rate Mortgage (ARM), or paying points ahead of time.

Click here to get today’s latest mortgage rates (Jul. 4, 2022).

Property Eligibility for FHA and Conventional Loans

Just because you qualify for a mortgage doesn’t necessarily mean your future house will. Since FHA home loans are backed by the government and meant to help families, they place more restrictions on the sort of house that qualifies.

FHA Property Guidelines

  • Must be occupied by the buyer
  • Must be your primary residence (i.e. not a vacation or investment property)
  • Must be occupied within 60 days of closing
  • Must be assessed for safety with an additional home inspection
  • Must be under the capped lending amount (this varies depending on location and property size)

Conventional Mortgage Property Qualifiers

Conventional loans have fewer restrictions. Second homes and investment properties both qualify, and you won’t need special inspections. They, too, have a capped loan amount called the conforming loan limit. 

The limit is $453,100 in most areas, though that number increases in high-cost areas and for multi-unit properties. If you need more financing than that, a jumbo loan is your next step.

Conventional 97 Property Qualifiers

Of course, it’s a different story if you’re planning on taking advantage of a conventional 97 loan to put just 3% down. As we outlined in our section on down payments, the requirements also dictate that:

  • The property must be a one-unit, single-family home, co-op, PUD, or condo.
  • The property will be the buyer’s primary residence
  • The buyer (or one of the buyers) can’t have owned a house in the last 3 years
  • The loan amount is at or under $453,100

Refinancing a Conventional vs. FHA Loan

With both loans you’ll be able to refinance into virtually any loan you want, changing term length, interest rate, and even taking cash out

Refinancing a Conventional Loan

The process of refinancing a conventional loan is quite similar to the process of getting approved. You’ll have to apply for a refinance, provide financial documentation, get approved, and go through a less involved closing process.

FHA Streamline Refinance

If you’re refinancing from an FHA loan to another FHA loan, you do so using a special program, called FHA streamline refinance. It generally allows you to refinance with:

  • No new credit score
  • No new appraisal
  • No new income verification

Cash-Out Refinances: Conventional vs. FHA Loan

Cash-out refinances allow homeowners to tap into the equity they’ve built up in their home, increasing their remaining loan amount in exchange for liquid cash. You can use this money to finance renovations, investments, or an education.

Conventional refinances allow homeowners to take a new loan for up to 80% of what their property is worth. Keep in mind that this process requires a new home appraisal. 

Example

Let’s say your property is worth $100,000 and you have 60% equity, or $60,000 paid off. 

With a conventional cash-out refinance, you’ll be able to take out a refinance loan for up to $80,000. Once you pay off the remaining loan balance of $40,000, you’ll be left with $40,000 in cash and a new mortgage for $80,000.

Meanwhile, FHA loans allow for a loan-to-value ratio (or LTV) of up to 85%, giving owners the opportunity to take more out of their equity.

Can You Switch from an FHA Loan to a Conventional Loan?

Under current lending requirements, you can refinance from an FHA loan to a conventional mortgage after making six months of payments on time using an FHA streamline. 

The odds of approval are higher if the home has increased in value (the home now has at least 20% equity) or if the borrower has improved their credit score during this time. 

Lenders want you to have a DTI ratio of less than 43%, which means that less than 43% of your income before taxes is paid toward the mortgage, credit cards, loans, student loans, auto payments, and other forms of debt. 

Refinancing to a conventional loan from an FHA loan makes sense if your family is planning on staying in the home long enough to recoup closing costs or interest rates have gone down at least one percentage point.

Can You Switch from a Conventional Loan to an FHA Loan?

Yes, you can switch from a conventional loan to an FHA loan. Some borrowers will choose to refinance from a conventional loan to an FHA loan in order to pull equity out of the home for renovations, like a cash-out, to pay off existing liens, or in the event of a negative equity situation. 

In order to qualify, lenders would like to see:

  • At least 12 months of on-time payments
  • Use the home as your primary residence for 12 months or longer
  • You have a credit score between 620 and 640

The only time these rules don’t apply is in the event of inheritance where you haven’t used the property as an income-producing property since the inheritance occurred. 

If you have used it for income, you must occupy the property for 12 months as your primary residence before qualifying for equity cash-out.

Which Is the Best Option for You: FHA or Conventional Mortgage Loans?

Neither loan is objectively better than the other.  It all ultimately depends on you, your financial situation, and your plans for the future.

When to opt for an FHA loan:
  • You have lower or no credit
  • You have a lot of debt already
  • You already have an FHA loan and want to refinance
  • You don’t plan on staying in the home long enough to hit 20% equity (meaning you’ll be paying PMI either way)
  • You have a bankruptcy or foreclosure in your past
When to opt for a conventional loan:
  • You have fair to excellent credit
  • You have a reasonably low DTI ratio
  • You need to be able to make the smallest possible down payment
  • You want to be able to dump PMI without having to refinance
  • You’re buying an investment property or second home

Apply for an FHA loan or Conventional loan with Total Mortgage

Both FHA and conventional loans have their unique limits, disadvantages, and benefits. Choosing the right loan option for you will depend on your financial situation. 

If you need help making the right decision, find a Total Mortgage lender near you and schedule an appointment with one of your financial advisors. 

You can also visit our MyMortgage Builder if you want a personalized loan recommendation.

By answering a few simple questions about your goals and status, you’ll receive a shortlist of loans that make sense for you.


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1 Comment

  • gagerobertsonhathaway@yahoo.com' Gage says:

    This was a great video. It was short, easy, and informative. One thing I would like to touch on is the reference to F.H.A loans having P.M.I. F.H.A loans do not have P.M.I; rather they have M.I.P (Mortgage Insurance Premium).

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