FHA Loans vs. Conventional Loans – What Are the Differences?

Before I jump into the answer, I wanted to briefly point out that in this article the word conventional refers to conforming mortgages, which fall under the guidelines of Fannie Mae and Freddie Mac.

FHA Loans vs. Conventional Loans

Mortgages are not one size fits all. Each person or family’s situation is a little unique and determining which loan is the best fit can be difficult. I’ll cover the basics of how FHA and conventional loans differ and compare, but please keep in mind that reading a blog post will never replace the consultation of a trusted mortgage professional.

Major differences

There are many ways that these two loan types differ, but in my opinion, these are the largest categories:

• Down Payment/Equity in Home
• Loan Amount
• Credit Sensitivity
• Mortgage Insurance
• Interest Rates
• Occupancy
• Guidelines

I’ll go through these categories one at a time.

Down Payment/Equity in Home

FHA:

• 3.5% minimum down payment (purchase)
• 2.25% minimum equity for standard refinances (except streamline refinances, which have no minimum equity)
• 15% minimum equity for cash out refinances
• Upfront and monthly mortgage insurance, regardless of down payment or equity in home

Conventional:

• 3% minimum down payment for first time homebuyers (at least one borrower has not owned a home in the last three years)
• 5% minimum equity for all others purchasing or completing a rate and term refinance
• 20% minimum equity for cash out refinances
• No mortgage insurance with 20% down payment or equity in a refinance

Summary: The main point to take away is that the minimum down payments are similar, but the more money you have available to put down, the more attractive the conventional loan option will likely be. Since FHA loans have mortgage insurance regardless of down payment, borrowers who are able to put down larger sums usually lean toward conventional loans. I’ll provide more information on the “why” in the mortgage insurance section coming up.

Loan Amount

FHA:

• Varies by county
• Up to $314,827 in most of Arizona, higher in some “high cost” counties
• Typically the maximum loan amount in each county is lower than conventional, though occasionally they are the same

Conventional:

• Varies by county
• Up to $484,350, higher in some “high cost” counties
• At least the same as, but typically much higher than, FHA limits

Summary: This is pretty straightforward. The limits on conventional loans are either the same or higher than FHA loans for each county. FHA loan limits can be a limiting factor for some borrowers.

Credit Sensitivity

FHA:

• Minimum credit score is 500 by FHA guidelines, but most lenders require a 580 or higher
• More forgiving on major credit issues (bankruptcy, foreclosure, short sale)
• 2 years minimum after bankruptcy discharge*
• 3 years minimum after short sale*
• 4 years minimum after foreclosure*
• Interest rates less credit sensitive
• Mortgage insurance premiums less credit sensitive

Conventional:

• Minimum credit score is 620 across all lenders, though some lenders may choose to have higher minimum guidelines
• Less forgiving on major credit issues (bankruptcy, foreclosure, short sale)
• 4 years minimum after bankruptcy discharge*
• 4 years minimum after short sale*
• 7 years minimum after foreclosure*
• Interest rates more credit sensitive
• Mortgage insurance premiums more credit sensitive

Summary: This category is also pretty straightforward. FHA is more lenient on credit score minimum and waiting periods after major derogatory items. Interest rates with FHA loans vary a lot less with lower credit scores versus higher credit scores. Conventional loans, on the other hand, swing wildly as the borrower’s credit score does. Mortgage insurance (more on this shortly) is not dependent on credit scores for FHA loans, whereas conventional mortgage insurance rates rely heavily on credit score a determining factor.

*These waiting periods may be shorter if the borrower or borrowers qualify for extenuating circumstances. In my experience, extenuating circumstance exceptions are difficult to qualify for.

Mortgage Insurance

FHA:

• Referred to as Mortgage Insurance Premium (MIP) on FHA loans
• FHA has upfront and monthly MIP
• Monthly MIP is determined by down payment (or equity if refinancing) and loan term, credit and other items are not factors
• Most common MIP is 0.85% annually, which applies to 3.5% down payment, 30 year fixed loans.
• If putting less than 10% down, the monthly MIP stays on for the life of the loan
• If putting more than 10% down, the monthly MIP stays on for a minimum of 11 years

Conventional:

• Referred to as Private Mortgage Insurance (PMI) on conventional loans
• Conventional loans that require mortgage insurance have either monthly or single premium payments, not both
• Premium is determined by a variety of factors, including credit scores, loan term, occupancy, down payment (or equity if refinancing) and home type
• Mortgage insurance on conventional is automatically cancelled once the homeowner reaches 78% loan-to-value

Summary: Mortgage insurance is a complicated topic, which is why I’ve written an entire separate post on it: What is mortgage insurance and why do I have to pay it? When it comes to mortgage insurance, the general idea on the differences between FHA and conventional are the same as they are for just about every category we’ve covered: The higher your credit score and down payment/equity, the higher the likelihood of choosing a conventional loans The lower your credit score and down payment/equity, the higher the likelihood of choosing an FHA loan.

Interest Rates

FHA:

• Lower than conventional interest rates (at least in today’s environment)
• Less credit sensitive

Conventional:

• Higher than FHA interest rates
• More credit sensitive
• At least the same as, but typically much higher than, FHA limits

Summary: Essentially, across loan scenarios, FHA interest rates will be lower than conventional interest rates will be (in today’s market). The gap between the available rates widens with borrowers who have lower credit scores since conventional loans penalize for lower scores and FHA rates are less concerned with that aspect.

Occupancy

FHA:

• For purchases, only primary residence loans are allowed
• Most refinances are owner-occupied as well
• For refinances, investment loans are possible, but not nearly as common and further guidelines (rules) apply

Conventional:

• Primary residences, second/vacation homes and investment properties are all allowed

Summary: Beyond a few rare instances, FHA loans are mostly for primary residences, while conventional loans allow for all occupancy types.

Guidelines

Summary: Guidelines are just another way to say “rules of the program”. This is another broad topic, but as you have seen in the other categories mentioned, FHA generally has more relaxed guidelines when it comes to bruises on credit and what is and isn’t allowed (with the exception of occupancy). Some loans which would not receive approval through a conventional program are able to gain approval through FHA, but the reverse is rarely true.

Starting to sense a theme?

No two borrowers are the same and how “qualified” they are is a pretty broad spectrum. Think of it like this:

– The more statements from the right side of the spectrum apply to you, the more likely it is that a conventional loan will make the most sense.
– The more statements from the left side of the spectrum apply to you, the more likely it is that an FHA loan will make the most sense.

This post has covered the general ground rules of the programs, but my best advice (of course) is to contact a mortgage professional to discuss your specific scenario and determine which loan type best suits you and your family’s needs and goals. 

Thanks for reading my blog! If you found this information helpful, please share it with others.