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FHA vs. Conventional Loan

Updated
Matt Frankel, CFP®
By: Matt Frankel, CFP®
Matt Frankel, CFP®
Matt Frankel, CFP®
Writer, Analyst

Matt is a Certified Financial Planner™ and investment advisor based in Columbia, South Carolina. He writes personal finance and investment advice for The Ascent and its parent company The Motley Fool, with more than 4,500 published articles and a 2017 SABEW Best in Business award. Matt writes a weekly investment column ("Ask a Fool") that is syndicated in USA Today, and his work has been regularly featured on CNBC, Fox Business, MSN Money, and many other major outlets. He’s a graduate of the University of South Carolina and Nova Southeastern University, and holds a graduate certificate in financial planning from Florida State University.

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When looking for a mortgage to buy a home, most Americans choose either an FHA loan or a conventional mortgage loan. But when comparing an FHA vs. conventional loan, how do you know which is best? We'll take a closer look at these mortgage types and the pros and cons of each, so you can decide which is the better fit for your situation.

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What's the difference between FHA and conventional loans?

The biggest difference between an FHA vs. conventional loan is that FHA loans are guaranteed by the Federal Housing Administration. In other words, if a borrower defaults on an FHA loan, the government covers the balance. A conventional loan has to meet certain lending standards set by Fannie Mae and Freddie Mac, but isn't guaranteed by any government agency.

Because of that, FHA loans are usually easier to qualify for. They represent minimal risk to the lender, so borrowers can get FHA loans with lower credit scores than conventional loans.

How to compare FHA and conventional loans

Let's take a closer look at how an FHA vs. conventional loan would compare in important categories for mortgage borrowers.

FHA vs. conventional loan comparison table

Here's a rundown of how each of these categories stack up:

Factor FHA loan Conventional loan
Credit score requirements 580 with a 3.5% down payment, 500 with a 10% down payment 620-720, depending on the situation
Down payments 3.5% 3%-25%, depending on the situation
Interest rates Competitive for all borrowers Depends heavily on the borrower's credit score
Uses 1-4 unit properties, but only for owner-occupied homes 1-4 unit properties, owner-occupied homes, vacation homes, and investment properties
Standard loan limit (2020) $331,760 $510,400
Costs Upfront mortgage insurance and ongoing premiums for the duration of the loan PMI required, but only for down payments below 20%. Only ongoing premiums, and can be dropped when you reach an 80% loan-to-value.

Credit score requirements

Conventional loans require a minimum credit score (FICO® Score) of 620, according to the latest Fannie Mae Eligibility Matrix. That's generally considered a fair-to-good credit score. Lenders can set their own minimums, but 620 is the rock-bottom requirement.

Also, not all borrowers qualify for a conventional loan with a 620 credit score. For example, let's say you have a debt-to-income ratio in the 36%-45% range (your monthly debt payments cost about one-third to one-half your monthly income). You want a down payment less than 25%. To do that, you'd need a score of at least 720. Minimum credit score requirements for conventional loans can range from 640 to 700, depending on the details of the loan.

On the other hand,FHA loan requirements are straightforward. With a minimal down payment, which we'll look at in the next section, you need a credit score of 580 or higher. With a down payment of 10% or more, you can get an FHA loan with a credit score as low as 500.

Down payment requirements

The down payment requirement for a conventional loan depends on the lender, the type of property, and the borrower's qualifications.

There are conventional mortgage loans with down payment requirements as low as 3%. To qualify, a borrower needs to have strong credit and other factors. Conventional loan minimum down payment requirements range from 3% to as high as 25%, depending on the situation. Some of your down payment can come from a down payment gift (and under some circumstances, your entire down payment can come from a gift).

On the other hand, FHA loan down payment requirements depend on the borrower's credit score. If the borrower has a 580 or higher, a 3.5% down payment is the minimum required. With a score in the 500-579 range, the borrower needs at least 10% down. One hundred percent of your down payment can come from a down payment gift.

Interest rates

Interest rates vary depending on the borrower's qualifications, but this is more of a factor with conventional loans. Borrowers with excellent credit can get conventional mortgage rates significantly below the market average. Unfortunately, borrowers with so-so credit often have to pay much more.

For example, as I write this the national average for a 30-year fixed-rate conventional mortgage is about 2.8%. With excellent credit (760 to 850), the average rate is just 2.42%. But if you have the 620 minimum FICO® Score required for a conventional loan, you can expect a rate of about 4.0%.

When you calculate your monthly payment, the interest rate can make a big difference. Also, these rates change over time. Compare current mortgage rates before you start budgeting.

With FHA loans, interest rates can vary somewhat. Generally, all FHA borrowers receive FHA mortgage rates close to the national average -- even with borderline credit. Higher interest rates are intended to compensate mortgage lenders for poor credit borrowers and the additional default risk that comes with them. But because the government guarantees all FHA loans, there's little extra risk associated with low credit borrowers.

Uses

Both FHA and conventional loans can be used to purchase properties with as many as four housing units. But there are some subtle differences.

FHA loans are only for owner-occupied properties. So you can buy a multi-unit property like a triplex, but you need to live in one of the housing units. The same 3.5% down payment and credit score requirements apply, even for multi-unit properties. FHA loans are excellent for a popular investment strategy called "house hacking." That's when you buy your first investment property with an FHA loan, renting out the units you don't live in. (This was my own first type of real estate investment.)

Conventional loans allow you to buy properties with as many as four units, but not with a low down payment. Duplex properties require at least 15%, while three- to four-unit properties require a down payment of 25% or more.

Another distinction is that conventional loans don't have an owner-occupancy requirement, so they can be used to acquire a vacation home or an investment property you don't live in.

Loan limits

Both FHA and conventional loans have size limitations.

FHA loans are intended to help lower- to middle-income Americans become homeowners. As a result, their requirements are more strict. In most parts of the United States, as of the writing of this guide, the FHA loan limit for a single-unit home is $331,760. However, this can be as high as $765,600 in higher-cost housing markets, and is even higher in Alaska and Hawaii. There are also higher limits that apply for borrowers who buy multi-unit homes.

For conventional loans that conform to the lending standards of Fannie Mae and Freddie Mac, the standard loan limit is $510,400 (at the time this guide was written). High-cost markets have the same upper limit of $765,600 as FHA loans.

It's worth mentioning that you can get a conventional loan for an amount in excess of these limits -- called a jumbo loan. But these loans may have stricter credit and down payment standards.

Costs

The biggest downside to an FHA loan vs. conventional loan is the cost.

With an FHA loan, you're required to purchase FHA mortgage insurance. That's where the government guarantee comes from. It has an upfront premium and ongoing premiums, and in most cases is impossible to get rid of for the life of the loan.

On the other hand, conventional mortgages with at least 20% down have no mortgage insurance requirement. With lower down payments you have to buy private mortgage insurance, or PMI. However, this typically only has annual premiums (with no upfront cost). And you can get rid of it when your loan is paid down to the same amount you would have borrowed with a 20% down payment

FHA vs. conventional loan: Which is better?

There's no one-size-fits-all answer here. Some borrowers are better off pursuing an FHA loan, while others might find a conventional mortgage loan the better option.

Generally, an FHA loan is better if:

  • You have a below-average credit score.
  • You don't have a ton of money to put down.
  • You want to buy a two- to four-unit property with a low down payment.

On the other hand, conventional loans are better for:

  • Borrowers with good credit
  • Borrowers who have larger down payments available
  • Borrowers who want to buy a vacation home or investment property

The bottom line? Learn about both loan types, then get pre-approvals and rate quotes from some of the best FHA lenders and best conventional mortgage lenders. That way you can not only compare mortgage lenders, but see which mortgage type is the better option for you.

Still have questions?

Here are some other questions we've answered:

FAQs

  • The biggest difference in FHA vs. conventional loans is that FHA loans are guaranteed by the Federal Housing Administration. For this reason, FHA loans are generally easier to qualify for. Borrowers can get FHA loans with lower credit scores than conventional loans.

  • An FHA loan is better if you have a below-average credit score or if you need a low down payment. You might be better off with a conventional loan if you have good credit or if you want to put down a large down payment to avoid mortgage insurance costs.

  • For borrowers with below-average credit scores, FHA loans often have lower interest rates because the loan is backed by the government. But this depends on the borrower and situation.