FHA vs. Conventional Loan: Which is Right for You?

When you feel ready to buy a house, different types of loans may be available to you. Two primary mortgage options are an FHA loan and a conventional loan. Below, we briefly compare each to help you understand which might be right for your situation.

What is an FHA Loan?

The Federal  Housing Administration insures FHA loans. The government-backed loans have less stringent borrowing qualifications. Some people go with this type of loan if they don’t have a big down payment or they have a lower credit score.

What is a Conventional Loan?

Conventional loans aren’t issued, nor are they guaranteed by a government agency. Private lenders insure these loans. You’ll need a better credit score and lower debt-to-income ratio to qualify for a conventional loan, as well as a down payment of usually at least 20%.

A conventional loan is also known as a conforming loan because they conform to standards set by Fannie Mae and Freddie Mac. These groups buy mortgages from lenders, holding them or turning them into mortgage-backed securities.

You can opt for a conventional loan with a fixed rate interest rate or an adjustable rate. The terms of a conventional loan usually range from 10 to 30 years, with 15 and 30-year mortgages being the most common.

Below, we look more comprehensively at some of the differences between these two primary home loan types.

Credit Score

Your credit score is three digits, and it can be anything from poor to excellent. According to most lenders, a poor score is anywhere from 350 to 570, with an excellent score being anything 800 and above.

The bulk of lenders will look at the FICO Score. The FICO Score is a credit scoring model created by the Fair Isaac Corporation. There’s also the VantageScore model.

Three credit bureaus report credit scores: Experian, Equifax, and TransUnion. Your scores can vary between the three.

Credit score depends on your history of making on-time payments, your mix of types of credit, how long your credit history is, and how you use your credit.

Most lenders require that you have at least a 620 to qualify for a conventional loan but generally like to see scores higher than this. For an FHA loan, you can qualify with a score as low as 500 because there’s less risk for the lender since the government backs the loan.

The lower your score, the more of a down payment you have to put down.

Down Payment

A 20% down payment is usually the standard for a conventional loan. Not everyone has 20% down for a house, though. You don’t have to put this much of a down payment on a house, but with a conventional loan, if you don’t, you’ll have to pay for private mortgage insurance or PMI.

To get an FHA loan, if you have a credit score that is at least 580, your down payment can be as small as 3.5%. If your score ranges from 500 to 579, you have to put 10% down.

Interest Rates

Several key factors influence mortgage interest rates, including demand, the condition of the economy, and the Federal Reserve. Lenders also look at your financial history, how much you’re borrowing, and your down payment when deciding on your interest rate.

If you want lower interest rates, you pay lender discount points. Then you can have a lower monthly payment.

The FHA interest rates are often comparable with conventional mortgages and based on similar factors.

Loan Limit

This year, the conventional loan limit in the lower 48 states is $647,200. In Alaska and Hawaii, it’s $970,800. In high-cost areas, it’s also $970,880. Someone who wants to get a loan that’s more than these limits would have to get a jumbo loan.

Jumbo loans are non-conforming because Fannie Me and Freddie Mac don’t back them. The underwriting guidelines are stricter, and they’re harder to get.

For an FHA loan, the limit depends on where you’re buying. The upper limit in counties considered low-cost is $420,680. In the high-cost county, the highest limit is $970,800.

A conventional loan tends to make the most sense for people who have a credit score of a minimum of 620, a down payment of at least 20% to avoid PMI, and a low debt-to-income ratio. An FHA loan might be good for a borrower who doesn’t have a high credit score, has a higher DTI, or has less money available for a down payment.