FHA VS. Conventional Mortgage

25, January, 2023

Buying a home is a big decision and one that can seem immensely daunting at times. There are many aspects to navigate when buying a home, including the type of loan you should go for. Trying to decide between an FHA loan vs. a conventional mortgage is a common one that many prospective homeowners face, and there are many considerations to keep in mind.

To help you in the decision-making process, this article will outline both types of loans, FHA vs. conventional mortgage, including requirements and the pros and cons of FHA vs. conventional mortgage.

FHA vs. Conventional Mortgage

At their core, both the Federal Housing Association (FHA) and a conventional mortgage are a type of loan you can obtain when purchasing a home. What type of loan you will obtain will depend on a number of factors, including the purchase price of the home, the loan amount, your debt-to-income ratio, and your credit scores. However, it’s essential to explore all available options when it comes to mortgage loans to ensure you are choosing the best choice for your circumstances.

Let’s look at both the FHA loan and the conventional mortgage in more detail and the main differences between the two.

What is a conventional mortgage?

A conventional mortgage refers to a loan that is guaranteed and insured by a private lender rather than a government agency. With a conventional loan, private lenders will use a variety of different factors when deciding whether to approve a loan.

Conventional mortgage requirements

The exact conventional mortgage requirements will vary from lender to lender, but there are some broad requirements to consider when considering a conventional mortgage. To qualify for a conventional mortgage, borrowers will need to show a higher credit score and a low debt-to-income ratio and will need to have a down payment ready when purchasing their home. Conventional mortgage options include a fixed-rate mortgage or an adjustable-rate mortgage.

What is an FHA mortgage?

An FHA mortgage is a government-backed loan with less strict qualification requirements. In addition, the FHA loan is insured by the Federal Housing Administration rather than a private lender. Therefore there is some flexibility with these types of home loans in some cases depending on your financial situation.

FHA mortgage requirements

Requirements for an FHA mortgage tend to be less restrictive overall, and critical requirements for these types of loans include a lower credit score (e.g., above 500), a debt-to-income ratio of 50% or less, and a down payment requirement that will vary based on credit score.

Differences between FHA and conventional loans

As you research conventional vs. FHA loans, you will likely see some of the clear differences that emerge between the two, including loan terms, debt-to-income ratio requirements, and credit score. The requirements for an FHA loan can be less restrictive than a conventional mortgage in various ways, so exploring both options should definitely be a priority while purchasing real estate. Let’s explore some of the crucial differences between the loan terms regarding FHA vs. conventional mortgages.

Down payment amount

One of the key differences that emerge between FHA vs. conventional mortgages is the down payment. The size of your down payment will differ in these situations, which is an important consideration when evaluating your overall financial situation. With the FHA loan, you can put down less than 20% for your down payment, depending on your credit score. For example, if your score is 580 or higher, you can put down 3.5% as the down payment.

Debt-to-income ratio or DTI

You’ll see debt-to-income ratio come up a lot in the lending process, which essentially refers to how much you earn versus how much you owe. You’ll need to take into account all your monthly payments, including loans and credit cards, as well as any recurring monthly fixed costs to work out what your DTI is. There are more stringent requirements when evaluating the debt-to-income ratio to qualify for a conventional mortgage than an FHA loan. The FHA loan typically looks for a debt-to-income ratio of 55% or below, while the conventional mortgage requires 50% or less.

Credit score

While both FHA loans and conventional home loans look at credit scores as part of the evaluation process, there are varying requirements in place. FHA loans are accessible home loans for lower credit scores, going down to 500. While the preferred credit score for FHA loans is 580, there is leeway for those that might be a bit lower than that. However, the lower credit score comes with stricter requirements around the down payment amount and DTI.

There might also be a higher annual percentage rate with a lower credit score with an FHA loan. Conventional mortgages, on the other hand, generally require a credit score of 620 or higher as part of their minimum qualification, although it may vary depending on the lender.

Mortgage insurance

Mortgage insurance is another variable to consider when looking at FHA vs. conventional mortgages. Depending on the loan amount and down payment, a private mortgage insurance (PMI) premium may be applied with a conventional mortgage. Certain instances, such as when the down payment is less than 20%, require mortgage insurance. If PMI is required, that can increase the monthly mortgage payment. However, FHA loans require a mortgage insurance premium (MIP) regardless of the down payment amount, and they last for the life of the loan, in most cases.

Property standards

The condition of the property being purchased, as well as how it will be used, particularly in low-cost areas, is another factor to consider when evaluating FHA vs. conventional mortgages. Compared to conventional mortgages, FHA loan appraisals take far more into consideration as the property must meet FHA Minimum Property Standards. For example, with the FHA loan appraisal, the property value is assessed and the home’s construction and condition must adhere to health and safety standards.

Moreover, the intended use of the home also matters as FHA loans can only be used to purchase a primary residence, they cannot be used to buy investment properties, vacation homes, or second homes. Conventional home loans, in comparison, can be used for primary, second, vacation, or investment home purchases.

2023 loan limits

Another difference between FHA vs. conventional mortgages to consider is FHA County loan limits.  Depending on the county the property is located, the maximum loan amount may vary. Single-unit home loan limits are between $472,030 to $1,089,300 in high-cost areas, with Alaska, Hawaii, Guam, and the U.S. Virgin Islands at $1,633,950.

Which loan is right for you? Conventional or FHA?

The decision to go for conventional mortgages vs. FHA loans will largely depend on your current financial situation and long-term financial goals. The FHA loan can be a viable option if you do not have a high credit score or a substantial down payment. On the other hand, if you are still determining whether your financial circumstances will change in the long run or if a conventional mortgage is the best option, then the FHA loan could be a suitable option.

Private lending has advantages that can make it beneficial to opt for a conventional mortgage. If your credit score is high enough and you can meet the requirements. Working with a mortgage lender is crucial during the home loan process to ensure that you have all the information you need to make the best decision possible based on your financial situation and circumstances.