What is the difference between FHA and conventional home loans?

Written by Bill MacDonaldSeptember 14th, 20225 minute read

Which loan is better, conventional or FHA? It depends on your income, credit score, employment & assets, and other differences between the two mortgage loans. Did you know you that you can borrow more money with a conventional mortgage? And that the FHA loan requires a minimum credit score of 500?

I know that this mortgage stuff is confusing. But, you should be congratulated for taking a few minutes to determine which mortgage loan is best for you. After all, you will probably make a monthly payment for the next 30-years. Here is a comparison of the FHA and conventional home loans.

1. Down payment requirements

FHA - The minimum down payment for an FHA home loan is 3.5%. No first-time home buyer requirement.

Conventional - The down minimum payment is 5%, however, Fannie Mae (conventional loan) offers two 3% down payment programs. The Conventional 97% program is limited to at least one first-time home buyer on the loan application. The HomeReady program does not have a first-time home buyer requirement, but, the household income must be at or less than 80% of the county median income.

2. Loan limits for FHA and conventional mortgages

The loan limits are set by Congress each year. There are some county exceptions, here are the typical lending limits for most US counties. For a home buyer seeking to purchase a $500,000 one unit home, the FHA home buyer will need a larger down payment than the buyer purchasing the home with a conventional mortgage. Loans that exceed the loan limits are known as jumbo mortgages.

2021 Single-Family Limit
$356,362 to $1,233,550 (see FHA Mortgage Loan Limits - 2021)
Conventional - $548,250

3. Seller paid closing costs (seller assist)

FHA - The FHA permits the seller to pay up to 6% of the sales price toward the home buyer's closing and prepaid costs. Read more about the seller paid closing costs.

Conventional - The generic conventional loan with a 5% down payment limits the home seller to 3% of the sales price for the seller paid closing and prepaid costs. With a down payment of 10% to 20%, the seller is permitted to pay up to 6% toward the buyer's costs.

4. Credit score prerequisites

FHA - The FHA permits a 500 credit score with a 10% minimum down payment. A credit score of 580 or greater will reduce the down payment requirement to 3.5%.

Conventional Loan - The minimum credit score for a fixed-rate mortgage is 620. For adjustable-rate mortgages, the minimum credit score is 640.

5. Upfront mortgage insurance

FHA - The FHA loans require a mortgage insurance premium that is paid in full at settlement. The "upfront" mortgage insurance premium percentage changes periodically. As of January 26, 2015 the upfront mortgage insurance premium is 1.75 percent on the base loan amount. On a loan amount of $100,000, the additional cost is approximately $1,750. The upfront mortgage insurance premium can be paid in full at settlement or can be financed in the loan ($100,000 + $1,750 = $101,750).

Conventional Loan - Conventional loans do not require upfront mortgage insurance.

6. Monthly mortgage insurance

FHA - The FHA loans require a monthly mortgage insurance premium, regardless of down payment. That's right, even if you have a down payment of 20%, you will have to pay a monthly mortgage insurance paymentwith your principal and interest payment. And get this, it never goes away. It doesn't matter how much equity you have in your house, that the monthly cost will be there. The only way to get rid of it is to refinance out of the FHA mortgage. The monthly cost varies based on down payment. The good news is that the mortgage insurance premium is not affected by the borrower's credit score.

Conventional Loan - The conventional home loans require mortgage insurance premium on loans with less than a 20% down payment (or equity, for refinance loans). But, the monthly mortgage cost goes away after the loan is paid down to 78% of the original loan amount or you can ask the lender to remove the PMI when you have paid down the mortgage balance to 80% of the home's original appraised value.

The mortgage insurance premiums are set by the private mortgage insurance companies. The monthly percentage cost is based on credit score, down payment (or equity), and other adjustments, such as whether the property is a second home, loan amount greater than $500,000, etc. It should be noted that the PMI companies also offer four-PMI payment plans. The Conventional 97 and the HomeReady programs also require mortgage insurance, although the cost is reduced.

7. Co-signer and Co-borrower

FHA - The FHA permits a co-signer to join the borrower on the mortgage application. Bringing on a cosigner or co-borrower can strengthen the application and possibly increase the loan amount and sales price.

Conventional Loan - The conventional loans are more restrictive with co-signed loans. Down Payment and Qualifying Ratio Requirements for Manually Underwritten Loans

8. Loan amortization

Both loans can be fixed or adjustable.

9. Occupancy types

FHA - Owner occupied 1 to 4 units.

Conventional Loan - Principal residence properties (1-4 units), second home properties, investment properties.

10. Interest rates

The FHA interest rates tend to be lower than the conventional interest rates. The reason is due to the risk associated with the conventional mortgages. FHA mortgages are "insured" by the federal government, because of the federal insurance, there is less risk.

Frequently Asked Questions About FHA Vs. Conventional Mortgages

Q. Are FHA closing costs more than conventional?
A. The closing costs are similar, with the exception of the mortgage insurance premium.

Q. Can I get rid of the PMI on my FHA loan?
A. Unfortunately, no.

Q. Can you get down payment assistance on a conventional loan?
A. There are numerous assistance programs. The Federal Home Loan Banks offer grant programs.

Q. Does credit score affect FHA interest rate?
A. The FHA has a clear advantage over conventional mortgages when it comes to interest rates. The FHA program does not have interest rate adjustments based on credit scores.

Q. How do I know if I have an FHA or conventional loan?
A. Take a look at the HUD-1. The HUD-1 statement is the closing disclosure that contains all the closing costs. At the top of the document you will find a check box that identifies the loan.

Q. Why do sellers prefer conventional loans over FHA?
A. Home sellers really don't know the difference between the two loans. Home sellers are directed by the real estate agent who believe that there are more complications with FHA home loans. Granted, the FHA appraisal is a bit tougher, but credit requirements on an FHA loan are lighter.