Should You Get an FHA or Conventional Loan?

You found your dream home, but now comes the hard part: figuring out your mortgage. Two common loan options are conventional and FHA loans. A Federal Housing Administration loan, or FHA loan, is insured by the federal government. A conventional loan is not. The backing of the federal government makes FHA loans a bit easier to qualify for because they’re considered less risky for lenders. But when it comes to conventional loans vs. FHA loans, which one is right for you?

Here’s what we’ll explore in this piece:

• Required credit scores
• Credit history impact on qualification
• Typical down payments
• Mortgage insurance requirements
• Typical interest rates
• Required debt-to-income ratio

Conventional Loan vs. FHA Loan

The key to deciding which loan you should get is understanding the characteristics of both programs and how they relate to your financial situation. You may be a good candidate for either program. If so, you want to select the loan that aligns with your payment and cash flow needs.

	FHA Mortgage Loan	Conventional Mortgage Loan
Required Credit Score	500+ credit score	640+ credit score
Credit History Impact on Qualification	Shorter wait times after negative credit events, such as foreclosure, short sale, bankruptcy and divorce	Longer wait times after negative credit events, though some lenders may be flexible depending on circumstances
Typical Down Payment	As low as 3.5%	As low as 3%, with advantages for a larger down payment
Mortgage Insurance	Requires both a 1.75% upfront premium and 0.45%-1.05% annual premium	Unless you make a 20% down payment, you must buy private mortgage insurance. Usually this is included in the cost of the loan and can be canceled when you have 20% equity or more
Typical Interest Rate	Lower interest rates than a conventional loan for many borrowers	Potentially higher interest rates than an FHA loan, unless you have stellar credit and a large down payment
Required Debt-to-Income Ratio	Higher debt-to-income ratio acceptable	Lower debt-to-income ratio than an FHA loan

Should You Get an FHA or a Conventional Mortgage Loan?

Let’s dig a bit more into each of those items to fully understand conventional loans vs. FHA loans. Each has different requirements, limitations, and expenses.

Required Credit Score

Typically, you don’t need as high of a credit score to get an FHA loan. That’s because the loans are backed at least partially by the federal government, so lenders are more willing to take risks on borrowers with substandard credit.

You usually need at least a 500 FICO score to be considered for an FHA loan, but a higher score is still better for your terms and options. For example, if you have a score of 580 or more, you can have a maximum loan-to-value ratio of 96.5%. That means if the property appraises for $100,000, you can borrow $96,500.

If your credit score is lower than 580, then FHA lenders can only approve you for 90% LTV. That means if the property appraises for $100,000, you can only borrow up to $90,000.

Requirements for a conventional loan vary by lender and situation, but on average, you’ll need at least a credit score of around 640. The better your score, the more likely you are to be approved for higher-value mortgages and the better your terms and rates are likely to be.

The Impact of Your Credit History

Your credit history—and not just your score—can impact whether you’re approved for a mortgage or not. FHA loans do tend to be more forgiving. For example, you only have to wait two years after filing Chapter 7 bankruptcy to be eligible for consideration for an FHA loan. In some cases, you might also be able to get an FHA loan for a home before you complete a Chapter 13 plan.

Conventional lenders may be less likely to approve you for such loans so close to a major negative credit event. In some cases, you might even need to wait until a major negative item has fallen off your credit report.

Down Payment Requirements

FHA loans typically require a minimum down payment of 3.5% of the purchase price. Conventional loans typically require a minimum down payment of 3% of the purchase price. But, how much your down payment should be depends on a variety of factors.

The more you put down, the less you finance. That increases your chances of getting approved. It can also reduce how much you pay each month for your mortgage and might even help you get more favorable interest rates—especially with a conventional loan.

Mortgage Insurance Requirements

Putting less than 20% down with a conventional loan means you’re forced to pay private mortgage insurance. That increases the cost of your home and your monthly payments.

In contrast, however, putting more down on an FHA loan doesn’t remove the required upfront premium and annual premium requirements for mortgage insurance. Because of this, if you have 20% to put down and decent credit, it might be cheaper to get a conventional mortgage.

FHA loans require a 1.75% upfront premium baked into your loan total. So, if you borrow $100,000, that’s another $1,750 you finance. Plus, you pay an annual premium of between 0.45 and 1.05%.

Typical Interest Rates

Loan rates for both FHA and conventional mortgages depend in part on your credit score. As of mid 2020, fixed 30-year FHA rates were around 3.3% on average. Conventional mortgage rates were around 3.6% on average.

Mortgage interest rates fluctuate with the economy, so it’s always important to shop rates and consider trends. Sometimes, you might want to wait a bit for rates to go down before you try to get any mortgage.

Required Debt-to-Income Ratio

Typically, both conventional and FHA loans require that you have a debt-to-income ratio under 43%. That requirement might be even lower if you don’t have excellent credit. FHA lenders typically won’t approve you for a loan that would cause your monthly mortgage to exceed 31% of your monthly income.

The Bottom Line on Conventional vs. FHA Loan

The bottom line is that there isn’t one single choice that is better for everyone. It’s important to understand your own credit and financial situation and ensure you look at all the details of any mortgage you’re considering. In some cases, FHA loans are easier to get and may offer benefits financially. In other cases, conventional loans lead to lower long-term costs.

Once you know where you stand, consider shopping for a mortgage online. You can check out different rates and apply for preapproval in minutes.

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