FHA vs. Conventional Loans
FHA and conventional loans are the two most common ways people buy a home, but they work a little differently, and one may fit your situation better than the other.
The right choice for you depends on things like your credit score, down payment, monthly budget, and the kind of home you want to buy.
- FHA loans allow borrowers with lower credit scores and higher debt amounts to qualify.
- FHA loans typically have lower upfront costs, while conventional loans typically cost less in the long run.
- For borrowers who don't have 720+ credit scores, FHA loans usually have lower interest rates than conventional loans.
A Neighbors Bank loan expert can help you compare your options.
Pros & Cons of FHA Loan vs. Conventional
An FHA loan is a mortgage program aimed to help expand homeownership among first-time homebuyers or borrowers whose credit scores or savings are still growing.
In exchange for their flexibility, FHA loans often require less cash upfront but cost more than conventional loans over time. On the other hand, conventional loans usually work best for buyers with higher credit scores or who want fewer restrictions on the property they buy.
Here's a look at conventional and FHA loan pros and cons side by side:
| FHA Loan | Conventional Loan | |
|---|---|---|
| Pros |
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| Cons |
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FHA vs. Conventional Loan Differences
One of the biggest differences between FHA and conventional loans is that FHA loans are backed by the Federal Housing Administration (FHA). This government backing allows lenders to offer more flexibility when reviewing an application, especially for buyers whose credit or finances don't fit neatly into traditional guidelines.
With FHA loans, if a homeowner defaults on their mortgage, the government will cover part of the lender's loss, which reduces the risk for lenders and simultaneously opens the door for more buyers.
Since conventional loans don't have this backing, they're riskier for the lender, which explains why they have stricter eligibility requirements.
Let's review how FHA loans and conventional loans differ in their requirements and costs.
Credit Score Requirements
Conventional loans usually require a minimum credit score of 660 to qualify; however, some lenders may allow as low as 620.
FHA loans generally allow for lower credit scores. In some cases, buyers can qualify with a score as low as 580 with a smaller down payment or even 500 with a 10% down payment.
These are minimum guidelines, though, so individual lenders may have stricter requirements.
Neighbors Bank typically requires a 620+ credit score for all loan types.
Down Payment Requirements
Both loan types allow for relatively low down payments, but the requirements differ slightly. FHA loans require a 3.5% minimum down payment as long as you have a 580 credit score or higher.
Certain conventional loan programs, like HomeReady® and Home Possible®, allow as little as 3% down, but they come with added income restrictions and usually require a minimum credit score of 660.
For traditional conventional loans, most lenders require a 5% to 10% minimum down payment.
Example Down Payment Comparison
| FHA Loan (3.5%) | HomeReady/Home Possible (3%) | Traditional Conventional Loan (5%) | |
|---|---|---|---|
| Example home price | $300,000 | $300,000 | $300,000 |
| Down payment amount | $10,500 | $9,000 | $15,000 |
Neighbors Bank offers down payment assistance. Get started here to view your options.
Average Closing Costs
Closing costs typically range from 2% to 6% of the mortgage loan amount for all mortgage loans. For example, on a $180,000 loan, that means closing costs could range from $3,600 to $10,800.
Planning for closing costs can feel challenging, especially on top of the necessary cash for a down payment. Thankfully, both loan types allow seller concessions and gift funds.
FHA loans allow seller concessions up to 6% of the loan's price, while conventional loans typically allow a maximum of 3% unless you provide a down payment of 10% or more.
Income & Debt Flexibility
FHA loans generally allow for higher debt-to-income ratios, which can help if you have student loans, car payments, or other monthly obligations.
Conventional loans tend to be less flexible in this area, especially if your credit score is closer to the minimum requirement. For employment, both loan types typically require stable income, often two years of work history in the same field.
Mortgage Insurance
Both FHA and conventional loans may require mortgage insurance, but they handle it differently.
With conventional loans, private mortgage insurance (PMI) is usually required if you put less than 20% down. The good news is that PMI can be removed once you reach 20% equity in your home, either through payments or appreciation. You pay PMI monthly as part of your mortgage payment, and it typically ranges from $100 to $200 per month.
With FHA loans, you pay a mortgage insurance premium (MIP) no matter your down payment amount. You'll pay an upfront premium of 1.75% at closing; however, most borrowers choose to roll this fee into their loan amount. FHA loans also have ongoing monthly premiums, which vary depending on your loan amount and down payment size. Most borrowers pay an annual MIP of 0.55%.
In most cases, MIP lasts for the life of the loan, though it can be removed after 11 years if you put at least 10% down at closing. You can also remove the fee by refinancing to a conventional loan later down the line.
Occupancy Requirements
FHA loans are designed for primary residences, meaning the home must be one you plan to live in as your main residence. While it is possible to buy a multi-family home with an FHA loan and rent out the additional units, you still have to occupy one of the units for at least a year. This focus helps FHA loans support owner-occupants who buy a home to live in, not invest in.
Conventional loans offer more flexibility. They can be used for primary homes, second homes, and investment properties, as long as you meet the program's qualifying requirements. This makes conventional loans a better fit if you're buying a vacation home or plan to rent the property out immediately.
Loan Limits
Loan limits are the maximum amount you can borrow for a certain loan type, and they apply to both conventional and FHA loans.
In most parts of the country, FHA loan limits are lower than conventional loans, while in higher-cost markets, they tend to be the same.
Here's a look at how loan limits compare between these loan options:
| Loan Type | Loan limit in most areas | Loan limit in high-cost markets | Loan limit in Alaska, Hawaii, Guam, and U.S. Virgin Islands |
|---|---|---|---|
| FHA | $541,287 | $1,249,125 | $1,873,687 |
| Cons | $832,750 | $1,249,125 | $1,873,687 |
Home Appraisal
All mortgage loan types require home appraisals. Appraisers determine a home's value to ensure that the list price is in line with the actual value and that lenders aren't paying for more than the property is worth. With conventional loans, the appraisal focuses mainly on value and major safety or structural issues. While FHA loan appraisals also evaluate the home for the FHA minimum property standards. This can make it slightly more difficult for older homes and fixer-uppers to qualify.
Which is Better?
Both FHA and conventional loans can help you become a homeowner. The right choice depends on things like your credit score, down payment, monthly budget, and the kind of home you want to buy. In general:
An FHA loan may be a good fit if...
- Your credit score is lower than 660.
- You don't have large savings.
- Your monthly debt obligations are higher.
- You want an easier path to qualifying, even if it means higher long-term insurance costs.
A conventional loan may be a better fit if...
- Your credit score is 660 or above.
- You want to borrow a higher loan amount.
- You want to buy a home that needs lots of repairs or updates.
- You want the option to remove mortgage insurance later.
Alternative Paths to Homeownership
FHA and conventional loans can both be great paths to buying a home, but the right fit depends on where you're starting.
If upfront costs are your biggest hurdle, you may qualify for additional options.
- VA loans are available to eligible Veterans, active-duty service members, and surviving spouses. These loans require no down payment, have no ongoing mortgage insurance, and offer flexible credit guidelines.
- USDA loans are designed for buyers in eligible rural and suburban areas. They also require no down payment and are built to support moderate-income households.
- Down payment assistance (DPA) programs help reduce the amount of cash you need to bring to closing. We offer DPA programs for FHA and conventional loans.
When you're ready, a Neighbors Bank loan expert can help you see which options may work for you.
