FHA vs. Conventional home loans

FHA loans can help homebuyers who don’t have a high enough credit score or a large enough down payment to purchase a home with a conventional mortgage. But FHA loans also come with permanent mortgage insurance payments, which drop off from a conventional loan after you’ve attained 20% equity. Dig into the finer points of each before deciding which makes the most sense for you.

How do FHA and conventional loans compare?

A 3.5% down payment and a minimum credit score of 500 makes government-backed FHA loans accessible to many first-time homebuyers and low- to mid-income borrowers. Conventional loans require higher credit scores, but the down payment can be slightly lower.

Both mortgage types are available through banks, credit unions and private mortgage lenders.

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Credit score requirements

Credit score minimums vary by lender for conventional loans. But most lenders prefer to see a score of at least 620 and offer the best rates to scores 740 and higher.

The US Department of Housing and Urban Development (HUD) set the minimum credit score for FHA loans at 500. Lenders can set stricter requirements on top of HUD’s guidelines.

Maximum loan amounts

Conventional loans backed by Fannie Mae and Freddie Mac have a maximum loan limit of $510,400 for a one-unit property in most areas. On the other hand, FHA loan limits vary by county. Most counties have a $331,760 loan limit. But some high-cost metropolitan areas may have limits up to $765,600.

Mortgage insurance

Lenders require private mortgage insurance (PMI) on conventional mortgages with less than 20% down. Once you’ve built at least 20% equity in your home, you can cancel PMI.

FHA loans come with mortgage insurance premiums (MIP), regardless of your down payment amount. While FHA mortgages issued before 2013 can be canceled under certain circumstances, mortgages originated on or after June 3, 2013 will generally include MIP for the life of the loan. This means that you can’t cancel your mortgage insurance until the loan is paid back in full.

Down payment

The minimum down payment for conventional loans vary from lender to lender and start at 3% of the loan amount. Government-backed FHA loans have a minimum 3.5% down payment requirement for borrowers with a credit score of 580 and above. If your score is between 500 and 579, you’ll need to put down at least 10%.

Fees

Conventional and FHA loans both come with the standard fees associated with getting a mortgage, including origination and appraisal charges. But FHA loans come with additional fees unique to its loan type. For example, you’ll need to pay the FHA funding fees, which include 2.25% of the mortgage paid upfront and an ongoing PMI of 0.85% of the loan amount.

DTI ratio

Lenders like to see a debt-to-income (DTI) ratio of no more than 43%. Some may allow a higher DTI if you can show some compensating factors, like a high credit score or generous cash reserves.

Restricted uses

Conventional loans are for qualified buyers who have some savings to put toward a down payment. You can’t use any down payment assistance programs and only a portion of your down payment can be a gift. And you can’t transfer your loan to another buyer.

On the other hand, you must live in the home you buy with an FHA loan. And all condos must meet specific guidelines, such as a high percentage of owner-occupied apartments, to receive FHA approval.

Refinancing

You can refinance both conventional and FHA loans. Conventional refinances generally require a credit check and income and employment verification. Refinancing an FHA loan may be easier, especially if you qualify for an FHA streamline refinance, which may not require as much paperwork.

Bottom line

If you’re a first-time buyer or have a low credit score, FHA loans could make your first home more accessible. However, conventional loans can cover your second home or investment properties and could save you on mortgage insurance. If you are still weighing your options, let us help you learn more about comparing mortgages.

Frequently asked questions

• Can I get an FHA loan for a foreclosed home?

  In most cases, yes. However, FHA loans are only issued if the house is FHA approved. Check with your lender to be sure.

• Can I use an FHA loan on new construction?

  Yes. This is called the one-time close mortgage and may be available through FHA-approved lenders.

• What are mortgage reserves?

  Mortgage reserves are essentially savings left over after you close on the purchase of a house. While they aren’t required, having mortgage reserves can reduce your risk as a borrower and could increase your chances of getting approved for a loan.