FHA vs. Conventional Loans: Key Differences

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FHA loans are government-insured mortgages that make sense for people with lower credit scores and smaller down payments, but they often don't let you borrow as much as conventional home loans. Conventional mortgages may be a better option for borrowers looking at properties that are bigger or located in more expensive areas.

Differences Between FHA and Conventional Loans

Traditionally, FHA loans allow lower credit scores, smaller down payments and lower loan limits than most conventional loans. And while several newer conventional loan options come close to the FHA loan in each of these areas, they still work differently from FHA loans when it comes to mortgage insurance and the funding sources you're allowed to use.

FHA Loan vs. Conventional Loan Minimum Requirements

FHA LoanConventional Loan
Down Payment3.5%3.0%
Credit Score580660
Debt-to-Income43%50%
Loan Limit$275,665$424,100

Comparison of minimum requirements on FHA loans and Fannie Mae HomeReady. In high-price markets, both FHA and conventional loan limits go up to $636,150.

Differences in Qualifying for FHA vs. Conventional Loan

FHA loans have looser credit requirements, but come with a lower loan limit in most US counties. Compared to conventional loans, FHA loans are also stricter about your debt-to-income ratio and what sources you use to pay for the loan. For instance, the FHA doesn't allow you to count certain types of income from non-borrowers or non-occupants as part of your loan application. This can be problematic for borrowers who plan on getting help from others to pay for a home loan.

In contrast, conventional mortgages allow bigger loans in most places and higher debt-to-income ratios. Unless you live in a high-cost area like a major city, the FHA loan limit is about $500,000 lower than the conventional limit. If you're buying a property that's more than $276,000, you won't be able to get an FHA loan. In addition, the higher debt-to-income limit means that people who already have significant levels of personal debt will find it easier to qualify for a conventional loan than an FHA loan.

Differences in Conventional and FHA Mortgage Insurance

An FHA loan will most likely cost you more in mortgage insurance premiums than a conventional loan. If your down payment is less than 20%, both FHA and conventional loans charge monthly mortgage insurance—but only conventional loans allow you to eliminate that extra cost later on. Not only does an FHA mortgage keep the monthly premium for the full life of the loan, it will also require an upfront mortgage insurance premium (UFMIP) of 1.75%. This is usually added to your initial FHA loan balance, meaning that you will start out owing more than what you pay for your house.

Differences in Borrower Requirements

Some of the conventional mortgage programs that are most similar to the FHA loan come with extra requirements on the borrower. For instance, the Fannie Mae HomeReady loan only allows borrowers whose incomes are less than or equal to the median income for their neighborhood. It also requires borrowers to take approved homeowner education courses as a way to reduce the risk of default. With so many different conventional mortgage options, you should find out if a particular mortgage has any special requirements before you get drawn in by an attractive rate or low down payment.

Which Loan Should You Choose?

FHA loans are better for borrowers with lower credit scores and less money available for a down payment. If you're living in a more expensive area like New York or San Francisco, you can also take advantage of the fact that FHA loans have the same limit as a conventional mortgage in such markets. However, you'll need to account for the extra cost of FHA mortgage insurance in your upfront and monthly expenses.

FHA LoanConventional Mortgage
Good For…
  • Borrowers with lower credit scores
  • People with less money for a down payment
  • Homebuyers in high-cost areas
  • People with higher debt-to-income ratios
  • People getting financial help from others on the mortgage

A conventional loan may work better if you're buying a more expensive, long-term purchase. You'll need better credit, but conventional mortgages let you borrow more and carry a higher debt-to-income ratio. Conventional loans also allow you to cancel mortgage insurance once you repay enough of your loan, which can reduce monthly costs for homeowners who plan on riding out the full term of their mortgage. Homebuyers relying on contributions from family will also want to choose a conventional loan, since government rules block those funding options for the FHA loan.

Keep in mind if you're looking for a second mortgage in the form of a home equity loan or HELOC, you'll likely be limited to conventional options. However, there are alternatives for FHA borrowers who are willing to consider other types of FHA financing to cash-out on equity. This will also depend on the purpose for which the funds are used.

Refinancing From FHA to a Conventional Loan

The main reason to refinance an FHA loan with a conventional home loan is to eliminate the permanent FHA mortgage insurance premium, which raises your monthly mortgage payment. However, there are possible disadvantages to leaving the FHA loan program. For one, FHA rates tend to be lower than conventional mortgage rates. If your new rate is too high, your monthly payment may not decrease by much, even after cutting out your mortgage insurance. You'll need to compare your current mortgage statement with any loan estimate you receive so you can calculate the difference in monthly payments.

Another potential pitfall of refinancing is that the closing costs of your refinance exceed the savings you'd get from the lower monthly payment. This can happen if you end up selling your home and paying back the full loan long before the end of your 15-, 20- or 30-year term. If you pay thousands to refinance at a lower rate or to cut out mortgage insurance, it will take many months before the savings catch up to that initial cost. Make sure you plan on staying in your home long enough for a refinance to make financial sense.

Calculating FHA vs. Conventional Loan Costs

If you're trying to choose between an FHA loan and a similar conventional mortgage program, it's best to calculate the difference in both your monthly payments and your closing costs. We looked at purchase estimates for a $200,000 home with the minimum requirements from each program.

FHA LoanFannie Mae HomeReady
Down Payment$7,000$6,000
Upfront MIP$3,500$0
Loan Amount$196,500$194,000
Interest Rate3.75%4.00%
Monthly P+I$910$926
Monthly Mortgage Insurance$136$89
Monthly Payment$1,046$1,115

Interest rates obtained from online lender estimates

In our scenario, the FHA loan required a slightly larger down payment but ended up saving $69 in monthly principal, interest and mortgage insurance payments. This doesn't account for the added cost of third-party services or homeowner's insurance, but such costs tend to stay fairly similar between FHA and conventional mortgages. If everything else holds equal, the FHA loan's lower monthly payment would recoup your higher down payment cost within 15 months and continue to save you money from there.

Of course, the final choice between a conventional mortgage or an FHA loan will depend on the actual loan estimates you receive. You might find that the closest lenders in your area don't participate in one or either loan program, leaving you to look for other loan types or different mortgage lenders. In the end, your personal circumstances will play a bigger role in the decision than the difference of a few hundred dollars.

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