FHA versus conventional loan: If you need a mortgage to buy a house, you may find yourself weighing these two options. What’s the difference, and which one is right for you?
While the majority of home buyers might assume they should get a conventional home loan, about 40% end up with FHA loans, which are insured by the Federal Housing Administration. To help you decide whether an FHA or conventional loan is better for your circumstances, here’s more information about each, including their distinct advantages to you as a home buyer as well as what you’ll need to qualify (which may vary by lender).
Conventional loan requirements
Minimum down payment: 5% to 20%
Minimum credit score: 620
Maximum debt-to-income ratio: 43%
Conventional lenders look for borrowers who have well-established credit scores, solid assets, and steady income, says Todd Sheinin, mortgage lender and chief operating officer at New America Financial in Gaithersburg, MD. As such, these loans have higher barriers to entry than the FHA-backed options. You’d better have your A-game on!
Typically, you need at least a 620 credit score and ideally a 20% down payment, although you can put down as little as 5% if you so wish—just know that on any down payment under 20%, you’ll have to pay private mortgage insurance, an extra monthly fee meant to mitigate the risk to the lender that you might default on your loan. (PMI ranges from about 0.3% to 1.15% of your home loan.)
Most conventional loans also require a maximum 43% debt-to-income ratio, which compares how much money you owe (on student loans, credit cards, car loans, and—hopefully soon—a home loan) with your income. So for instance, if your household take-home income amounts to $5,000 per month, that would mean you should spend no more than $2,150 per month on your mortgage and other debts.
Conventional loan advantages
- Conventional loans don’t require mortgage insurance, as long as you put down at least 20%.
- Conventional loans can cover higher loan amounts than FHA loans, which are restricted to county limits.
- Conventional loans, on average, are processed faster than FHA loans.
FHA loan requirements
Minimum down payment: 3.5%
Minimum credit score: 580
Maximum debt-to-income ratio: 50%
FHA loans are great for first-time buyers or people without sterling credit or much money. Created by the Federal Housing Administration, these loans are insured by this government agency, so that guarantees that lenders won’t lose their money if borrowers default on their mortgage. In short, it allows lenders to take on riskier borrowers, while also helping hopeful home buyers in less-than-ideal circumstances achieve the dream of homeownership.
To qualify for an FHA loan, you need at least a 3.5% down payment and a credit score of 580, says Tim Lucas, editor at MyMortgageInsider.com. Applicants with lower credit scores (e.g., 500) may not be out of the running entirely, but must cough up a larger down payment of at least 10%.
These loans also have looser debt-to-income requirements of up to 50%. So for example, if your monthly income is $5,000, your payments for your mortgage and other debts should not exceed $2,500.
FHA loans may be a boon to home buyers (particularly first-timers) who might not qualify for a loan otherwise, but they do have a few disadvantages. For one, they’re usually capped at $417,000 (in certain high-cost areas, the limit is $625,000)—meaning you may have limited buying power. Also, because the federal government insures these loans, you have to pay an upfront mortgage insurance premium (currently, the fee is about 1.75%) and annual mortgage insurance (typically 0.85% of the borrowed loan amount), which remains throughout the life of the loan (or until you can refinance the loan into a conventional mortgage).
FHA loan advantages
- FHA loans have lower down payment requirements (3.5%) than conventional loans (typically 5% to 20%).
- FHA loans have lower credit score requirements (as low as 580 for qualified borrowers).
- FHA loans have less stringent DTI requirements (50% or less) than conventional loans.
FHA vs. conventional loan: Which should you pick?
Generally if you have the means and qualifications to afford a conventional loan, this is the one to opt for, since it has fewer restrictions (and is faster to get). However, if you’re a less-than-ideal home buyer with a mediocre credit score, down payment, or income, then an FHA loan may be the best—or only—avenue open to you.
Check with your lender to know where you stand, or plug your numbers into an online home affordability calculator to get a ballpark idea of whether an FHA or conventional loan is right for you.