FHA vs. Conventional Loans: What You Need to Know
7 minute read
May 10, 2023


As you’re beginning your journey into homeownership, you may encounter the decision between an FHA loan and a conventional mortgage. You may go back and forth debating the mortgage option that’s best for you. 

Both are popular options that can help you buy a home but they come with different qualifications and requirements. Let’s dive into what you need to know about FHA loans and conventional mortgages to ensure you pick the right option.

FHA loans

FHA loans, backed by the Federal Housing Administration, offer several unique features and benefits. Particularly for first-time home buyers with low- to moderate-income or credit challenges. 

Minimum credit score requirements

FHA loans are easier to qualify for than conventional loans for people with lower credit scores. Borrowers can qualify for an FHA loan with a minimum credit score of 500, while conventional loans usually require a score of at least 620. 

There are some conditions: A credit score between 500 and 579 means you may need to make a 10% down payment. If you have a score of 580 or higher, you may qualify with just a 3.5% down payment. 

FHA loans are a good option for first-time homebuyers or those with limited credit history.

Down payment assistance programs

If you have little savings, you may still be able to buy a home with an FHA loan by combining it with down payment assistance programs. 

State and local governments or non-profit organizations offer these programs to provide grants or forgivable loans to qualified buyers. Using these programs, you can lower your initial costs and become a homeowner sooner.

Streamline refinancing opportunities

FHA streamline refinancing allows borrowers to refinance their current FHA loans with less paperwork and underwriting. This could lower your mortgage interest rates and monthly payments. 

It’s great for borrowers who have improved their credit scores or have seen lower market interest rates since getting their original loan. The process for FHA streamline refinancing is faster and simpler than traditional refinances, making it easier and more affordable to improve mortgage terms.

FHA loan limitations

Understanding the limitations of FHA loans is essential to making an informed decision. It’s important to know mortgage limits, property type restrictions, and occupancy requirements.

Mortgage limits by location

FHA loans have maximum loan amounts, which vary depending on the location of the property. These limits are based on median home prices in each area and are updated annually. 

Check the limits of your specific area to ensure an FHA loan will cover your desired property. This information can be found on the Department of Housing and Urban Development (HUD) website, which provides a lookup tool for FHA loan limits by county.

Property type restrictions

FHA loans are typically limited to owner-occupied, single-family homes, multi-unit properties with up to four units, and certain types of condominiums and manufactured homes. Investment properties and commercial properties are not eligible for FHA financing. 

The property must meet HUD’s Minimum Property Standards (MPS) to qualify for an FHA loan. These standards ensure that the home is safe, sound, and secure, and may require certain repairs or improvements to be made before the loan can be approved. 

Cosmetic improvements generally don’t violate restrictions. 

Common inspection items include: 

  • Asbestos 
  • Lead paint
  • Stairway rails
  • Functional appliances 
  • Water and heating
  • Condition of basement/crawl space
  • Functionality of bathrooms
  • Safe access to the home 
  • Condition of roof and foundation

Occupancy requirements

To qualify for an FHA loan, the borrower must plan to use the property as their primary residence. This requirement helps to ensure that FHA loans are used to promote homeownership rather than speculative investing. 

Borrowers may not have more than one FHA loan at a time unless they meet specific exceptions, such as relocation for work or an increase in family size that causes a larger home. The FHA aims to support sustainable homeownership and community stability by enforcing these occupancy requirements.

Conventional loans

Conventional loans do not have government backing but have their own distinct features that make them appealing.

Conforming vs. non-conforming Loans

Conforming loans follow rules set by Fannie Mae and Freddie Mac, who buy and insure mortgages. These rules include the maximum amount a loan can be, which changes every year and varies by location. 

Non-conforming loans, or jumbo loans, are for amounts that exceed these limits and may have stricter rules for approval. If you want to buy a property in a high-priced area, you may need to get a non-conforming loan.

Adjustable-rate mortgage (ARM) opportunities

Conventional loans offer adjustable-rate mortgage (ARM) options, which feature an initial fixed-rate period followed by an adjustable-rate period. 

The interest rate can fluctuate during the adjustable-rate period based on market conditions. This can cause lower initial monthly payments and may be a suitable option for borrowers who plan to sell or refinance before the fixed-rate period ends.

Fixed-rate mortgage benefits

Homeowners who plan to stay in the same home for a long time prefer fixed-rate mortgages, as they offer a constant monthly payment that remains the same throughout the loan period. This helps in budgeting and protects borrowers from any increase in interest rates.

Private mortgage insurance (PMI) options

Conventional loans with a down payment of less than 20% require private mortgage insurance (PMI) to protect the lender in case of default. PMI rates can vary based on the borrower’s credit score and down payment and may be paid upfront or at a monthly premium. 

Unlike FHA loans, PMI can usually be removed once the borrower has built at least 20% equity in the property, potentially lowering the overall cost of the loan.

Conventional loan requirements

Lenders will typically set their own requirements for a conventional loan. Since they’re not backed by any entities, they may be harder to qualify for with low or no credit. 

Credit score thresholds

Conventional loans generally require a credit score of at least 620, with more favorable terms and interest rates available to borrowers with higher scores. 

Lenders may also consider other factors, such as employment history, income, and debt-to-income (DTI) ratio when evaluating a borrower’s creditworthiness. A strong credit profile can cause more attractive loan terms and lower overall borrowing costs.

Down payment flexibility

Conventional loans provide more options for down payments. It’s possible to get a loan with just 3% down, but a higher down payment can lead to lower monthly payments and improved interest rates. 

If borrowers put down 20% or more, they can avoid PMI and cut down monthly mortgage costs even more.

Debt-to-income ratio requirements

A debt-to-income (DTI) ratio of 43% or less is ideal for conventional loans. Higher ratios are possible if the borrower has compensating factors like a good credit score or significant cash reserves. 

A lower DTI ratio suggests the borrower has a better balance between their debt and income, which makes them a more appealing candidate for a mortgage.

Choose the right loan (and lender) for your needs 

As you weigh the benefits and limitations of FHA and conventional loans, it’s essential to consider your unique financial situation, homeownership goals, and long-term plans. 

FHA loans may be more accessible to borrowers with lower credit scores or limited down payments. In contrast, conventional loans can offer greater flexibility and potentially lower costs for those with strong credit profiles and more substantial savings. 

AAA Banking can help you find the loan option that’s best for you. We want to be your ally in making your mortgage affordable, convenient, and personal. 

Contact us and get started to see where you stand so you can be one step closer to a homeowner.

Photo by Antoni Shkraba

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