FHA loan vs conventional loan: How to choose the right mortgage

As you consider which loan type best suits your borrowing needs, an FHA or a conventional loan can help you get the financing you need. Neither loan is better than the other, but each has different qualifying criteria and is designed to help borrowers in different situations.

An FHA loan is insured by the Federal Housing Administration (FHA), a federal agency. FHA loans tend to have more flexible eligibility requirements, providing a mortgage option for borrowers with lower credit scores.

However, you may pay more over the life of an FHA loan than with a conventional loan due to mortgage insurance requirements. That insurance helps protect the lender if the borrower defaults on the loan.

Most available mortgage loans are conventional loans. Conventional loans are not insured or guaranteed by the government, meaning the lender bears the risk themselves.

Conventional loans may have stricter eligibility requirements, but borrowers generally pay lower costs over time with this loan option, especially those with stronger credit or larger down payments. 

• Credit scores: Conventional loans generally have stricter credit score requirements than an FHA loan. FHA policy may allow lower minimum credit scores, while many conventional loans have a higher minimum, but lenders can set their own stricter criteria.
• Down payments: Lower down payments are permissible with an FHA loan. Keep in mind that a lower down payment requires monthly mortgage insurance for both loan options (see below).
• DTI: Lenders will look at your debt-to-income ratio (DTI), which is how your monthly debt compares with your monthly income. FHA loans generally have more flexible requirements than conventional loans, but each lender has their own eligibility criteria.
• Monthly mortgage insurance: All FHA mortgage borrowers must pay a mortgage insurance premium (MIP). Depending on the size of your down payment, you may be able to waive mortgage insurance after 11 years; otherwise, you will be required to have mortgage insurance for the life of your loan. Conventional loans will require you to pay private mortgage insurance (PMI) if your loan amount is more than 80% of the home’s original value. You can typically request it be canceled when the loan reaches 80%, and it often ends automatically at 78% if payments are current.
• Appraisals: When you obtain an FHA loan, your home must be appraised before you are approved. Conventional loans may also require an appraisal, although some loans may qualify for an appraisal waiver.
• Loan limits: Both mortgage types have loan limits, or maximum amounts that lenders or the FHA will insure. FHA loan limits are a percentage of conventional loan limits, but other factors, such as the property type or location, can also influence them.

Some first-time homebuyers may prefer an FHA loan because the qualifications are less stringent than those of a conventional loan. An FHA loan can still give you the borrowing power you need to make a home purchase if you:

• Have a lower credit score
• Want to make a smaller down payment or have less savings
• Are comfortable with paying mortgage insurance 

On the other hand, conventional loans may be a better choice for borrowers with stronger credit who want to compare long-term costs against FHA options. A conventional loan may be better suited for your needs if you:

• Have a favorable credit score and can make a larger down payment 
• Want a house that exceeds FHA loan limits 
• Want the ability to cancel mortgage insurance after the loan amount reaches 80% of the home’s original value.

If you qualify for both an FHA and a conventional loan, you can choose which loan will best suit your needs. Take the time to compare the total costs of borrowing with the following factors in mind to decide which option best fits your goals:

• Interest rate
• Annual percentage rate (APR), which factors in the total yearly costs on top of your interest rate
• Upfront costs
• Mortgage insurance 

In some instances, you may find sellers who favor borrowers with a conventional loan. Since conventional loans have stricter eligibility requirements, some sellers may perceive these borrowers as having better credit or finances. That said, it is still possible to work with a seller if you have an FHA loan, as preferences can vary by market.

Once you know which loan works best for you, follow these general steps to go through the homebuying process:

• Assess your readiness: Research what programs and grants are available, check your credit score, and review how much you’ve saved for a down payment and closing costs.
• Shop and compare offers: Work with a real estate agent to explore neighborhoods, create a list of what you want out of your home, and get personalized rate quotes to compare annual percentage rate (APR) and total loan costs to understand what you may be able to borrow and what each loan may cost over time.
• Submit an offer: Make an offer on the home you wish to purchase. Once your offer has been accepted, complete your mortgage application and provide documentation and additional information for your credit review.
• Close on your loan: Complete a home inspection or appraisal, review your loan details, and get ready to sign your closing documents. 

Explore a more thorough breakdown of the homebuying process.

Conventional loans and FHA loans both have their own benefits and drawbacks, so weigh the pros and cons of each option as you determine which loan works best for your overall goals.

Buying a home on a budget? Explore more articles and resources.

If you extend your loan term, you may pay more interest over the life of your loan.

If you are a service member on active duty, an eligible spouse, partner, or dependent, or currently receiving SCRA benefits, please consult with your legal advisor prior to seeking a refinance of your existing mortgage loan. In some cases, a refinance may impact your eligibility for benefits under the Servicemembers Civil Relief Act or applicable state law.