FHA vs. conventional loan: Understanding the differences

Conventional and FHA loans are the two most common hom loan types, totaling over 250,000 loans granted in the third quarter of 2023, according to Home Mortgage Disclosure Act data. These popular loans serve different types of buyers depending on credit score, down payment, and type of property being purchased. In this guide to FHA vs. conventional mortgage loans, learn about the features of each and their pros and cons to help you decide which is best for your home purchase.

What is an FHA loan? 

An FHA loan is a mortgage loan insured by the Federal Housing Administration, an agency that operates within the U.S. Department of Housing and Urban Development (HUD). The FHA’s insurance program, officially known as 203(b) insurance, protects lenders against borrower default. That protection allows lenders to extend loans to qualified borrowers who don’t meet the credit requirements needed for a conventional loan.

FHA loans are for owner-occupied primary residences only, but you’re not limited to standard single-family homes. You can use an FHA loan to finance a home with up to four units, whether existing or new construction, a condo, or a manufactured home. 

One benefit that contributes to FHA loans’ popularity, especially among first-time homebuyers, is the low down payment requirement. Borrowers with sufficient credit (a score of 580 or higher) can purchase a home with as little as 3.5% down using an FHA loan. In addition, the FHA allows third parties, such as the seller or lender, to contribute up to 6% of the loan amount toward closing costs.

The FHA doesn’t impose income limits for these loans, but it does have limits on the amount you can borrow. In 2024, that limit is $472,030 in low-cost areas, and $1,089,300 in high-cost areas ($1,633,950 in Alaska, Hawaii, Guam, and the U.S. Virgin Islands).

An FHA loan can have a fixed or adjustable rate and a loan term of up to 30 years. 

What is a conventional loan? 

A conventional loan is one that is not backed by a government agency such as the FHA.

Conventional conforming loans meet the criteria for purchase by Fannie Mae and Freddie Mac. Although sponsored by the government — they’re “government-sponsored entities,” or GSEs — Fannie Mae and Freddie Mac are private corporations that guarantee conforming loans to protect banks against borrower default. They also buy most conforming loans, which frees up resources lenders can use to make more loans.

One thing that makes a conventional loan a conforming loan is its lending criteria. These loans have fairly strict guidelines for credit score, income stability, debt-to-income ratio (DTI), and down payment. 

Conforming loans also fall within certain size limits. The conforming loan limit for 2024 is $766,550 in most areas and $1,149,825 for properties in Alaska, Hawaii, Guam, and the U.S. Virgin Islands.

You can use a conventional loan to purchase just about any property with four units or less, including a second home or investment property.

Conventional loans can have fixed or adjustable rates.

Key differences between FHA and conventional loans 

FHA and conventional loans are very different loan products geared toward different types of borrowers. Here are some of the biggest differences between the two: 

• Backing: Conventional loans are guaranteed by Fannie Mae or Freddie Mac, government-sponsored entities that buy conforming loans. FHA loans are insured by the FHA to encourage lenders to make loans to homebuyers who might not qualify for conventional loans.
• Down payment requirement: Conventional loan borrowers can buy a home with as little as 3% down with certain low-income products. FHA borrowers only need 3.5% down if their credit score is at least 580. The minimum down payment increases to 10% for buyers with lower credit scores of 500 to 579.
• Minimum credit score: Conventional loan borrowers need a minimum 620 credit score. FHA borrowers can be approved with a score as low as 500 if they have a large enough down payment.
• Maximum DTI: Borrowers need a DTI ratio of 45% or less to be approved for a conventional loan. With an FHA loan, homebuyers can have a higher DTI of 47%.
• Mortgage insurance requirements: Conventional loans typically require borrowers with a down payment of less than 20% to pay an annual private mortgage insurance (PMI) premium until their loan-to-value ratio (LTV) equals 80%. All FHA borrowers pay an upfront mortgage insurance premium (MIP) plus annual premiums for at least 11 years — and for the life of the loan if the borrower made a down payment of less than 10%.
• Eligible property types: Conventional loans can finance just about any one- to four-unit property, including a second home or investment property. Borrowers can use FHA loans for owner-occupied primary homes only.
• Loan limits: The standard limit for a conventional loan is $766,550. The standard limit for an FHA loan is $472,030 — 65% of the conforming FHA loan limit.

Pros and cons of FHA loans 

FHA loans play an important role in helping buyers afford a home, but they’re not for everyone.

Pros and cons of conventional loans 

Although more borrowers use conventional loans than any other type, there are situations where homebuyers can benefit more from other loans.

Which type of loan is right for you?

Each program is designed with a particular type of buyer in mind. If you're deciding between an FHA loan or a conventional loan, consider your financial situation and goals. Conventional loans are usually a better option for homebuyers with a larger down payment and credit scores above 620; they're also a better option for buyers who want a vacation or investment property. The loan limit is higher for a conventional loan, so if you're looking for a home in an expensive area, you won't be as limited by a price cap.

FHA loans, on the other hand, are designed to help homebuyers overcome credit and down payment hurdles they might encounter with other types of financing. It might be a better fit for buyers with a credit score between 500 and 620, or who don't have significant funds for a down payment. This is also a good option if you're looking for a fixer-upper home that requires some repairs or renovations. 

FHA vs. conventional loan FAQ 

Which loan is better for first-time homebuyers, FHA or conventional?

A conventional loan is usually better for first-time homebuyers who qualify for conventional financing and have at least 5% to put down. Even if you’re required to pay mortgage insurance, you can have it canceled when you reach 20% equity, no matter how soon you reach that milestone.

What are the credit score requirements for FHA vs. conventional loans?

The minimum credit score for an FHA loan is 580 with a 3.5% down payment, or 500 with a 10% down payment. Conventional loans require a higher credit score of at least 620. 

How do the down payment requirements differ between FHA and conventional loans?

The minimum down payment for an FHA loan is 3.5%, but you’ll have to put down 10% if your credit score is less than 580. The minimum down payment with a conventional loan is 5%, but Fannie Mae and Freddie Mac have programs for low-income borrowers that require just 3% down.

Are there different property requirements for FHA and conventional loans?

Yes. FHA properties must meet HUD standards for safety and durability. Conventionally financed properties must also be in good condition, but they’re evaluated based on Fannie Mae and Freddie Mac standards.

Can you refinance an FHA loan to a conventional loan?

Yes. In fact, one way to eliminate FHA mortgage insurance is to do a cash-out refinance into a conventional loan when you can do so with an LTV of 80% or less.