FHA vs Conventional Loan | Strong Home Mortgage LLC (2024)

I. Credit Score

For an FHA loan, a minimum credit score of 580 is generally required to qualify for the minimum 3.5% down payment. A 3.5% down payment equates to a 96.5% loan to value (LTV) ratio. An LTV ratio is a figure (expressed as a percentage) that represents the loan amount compared to the appraised value of the home.

A credit score between 500 and 579 may also be approved¹, but the maximum LTV will be 90%, which means the down payment will need to be at least 10% of the appraised value.

Those with a credit score of below 500 will not typically qualify for an FHA mortgage. On the other hand, a minimum credit score of 620 is generally needed to qualify for a conventional loan mortgage. While minimum requirements may vary by lender, credit score may prove to be a key differentiator in determining which is more appropriate, FHA vs conventional loan.

The credit score requirement for a conventional loan tends to be higher because the lender takes on more risk. A conventional loan lacks the government guarantee of an FHA loan.

If your credit score is in the low to mid-600s, an FHA loan may be a better option for you.

II. Debt-to-Income (DTI) Ratio

FHA limits the amount of debt a borrower may have in relation to their monthly income. To calculate DTI, divide your total monthly debts by your gross (pre-tax) monthly income. There are two types of DTI ratios FHA examines:

• “Front-end” ratio, which only looks at housing-related expenses
• “Back-end” ratio, which looks at total debt and can include auto loans, credit cards, and student loans

The max FHA DTI ratio is 31% for housing related debt and 43% for total debt. Although the ideal DTI is 43% for conventional mortgages, there are cases where the DTI can also be as high as 50%.

Strong Home Mortgage may extend DTI on FHA loans to 50% with higher credit scores, additional mortgage reserves, and other compensating factors. Ask your loan officer if you have any questions about DTI requirements, FHA vs conventional loan.

III. Down Payment

Many people assume a 20% down payment is required for a conventional loan. However, a conventional loan requires a slightly lower minimum down payment of 3% compared to the minimum down payment required on an FHA loan (3.5%).

Down payments can be funded from investments, bank accounts, and gifts. This is true for both mortgage types including FHA and conventional loans. Both loan types also allow 100% of the down payment to come from gift funds. However, when it comes to gifting funds, there are a few key differences between these two loan types.

The approved gift fund sources are much broader for an FHA loan. For a conforming conventional loan, the gift must come from a family member. FHA allows for gifts from family members, friends, labor unions, and employers. According to HUD, family members may also give FHA borrowers equity credit as “a gift on the property being sold to other family members.”

First-time homebuyers may also take advantage of down payment assistance programs which can make the borrower’s out-of-pocket down payment amount as little as 0.5%. Down payment assistance programs are available for each, FHA vs conventional loan.

IV. Interest Rates

The Federal Housing Administration insures all FHA mortgage loans and guarantees the FHA-approved lender in the event of default, which reduces the risk to the lender when issuing the loan.

The interest rate on an FHA loan or conventional mortgage is influenced by your credit score as well as the size of the down payment. Other factors include current market conditions, loan type (purchase, cash-out refinance), previous loan repayment history, and whether you opt for a fixed-rate or an adjustable-rate mortgage.

FHA loan interest rates generally appear to be more attractive than conventional loans depending on the loan size, down payment, and property. However, an FHA loan may be more costly when looking at the APR and other factors associated with the loan. These include FHA’s upfront and annual mortgage insurance premium (MIP).

Your loan officer will compare interest rates for you, FHA vs conventional loan.

V. Mortgage Insurance (MIP)

Most FHA mortgage loans require the payment of a mandatory Upfront Mortgage Insurance Premium (UFMIP) as well as annual Mortgage Insurance Premium (MIP), which covers the risk of default on your loan. The one-time 1.75% UFMIP is non recoverable except on an FHA Streamline Refinance.

A conventional mortgage requires private mortgage insurance (PMI) only when the down payment amount is below 20% of the purchase price. This insurance is designed to protect the lender should the loan default. PMI rates are based on your credit score as well as the loan-to-value (LTV) ratio. PMI is usually paid as a monthly fee. However, you may also opt for a lender-paid PMI scenario where the lender pays the insurance, and you pay a slightly higher interest rate to cover PMI.

PMI tends to cost more than the MIP on an FHA loan when the credit score is low. However, when the credit score is 720 or above, PMI can cost less than MIP. This is an important cost factor to weigh, FHA vs conventional loan.

VI. Loan Limit

Maximum loan limits apply to either option, FHA vs conventional loan. The Federal Housing Finance Agency (FHFA) sets the loan limits on conforming conventional loans, while the FHA sets the loan limits on FHA loans based on the geography. Low-cost areas are $420,860 and higher cost markets are $970,800.

The FHFA oversees Fannie Mae and Freddie Mac which are government-sponsored enterprises. Non-conforming conventional loans that aren’t backed by Fannie or Freddie (also known as Jumbo loans) don’t have restrictions on the loan amount. Conforming conventional loans must not exceed $647,200 (2022). In some parts of the country, this limit may be higher. For instance, Fannie and Freddie allow a loan amount up to $970,800 in certain state counties.

VII. Property Requirements

With an FHA loan, the property may only be used as a primary residence and must not be purchased within 90 days of the previous sale. For conventional loans, the property may be used as a primary residence, second home, vacation home, or investment property.

VIII. Bankruptcy

Bankruptcy doesn’t automatically disqualify you from either loan type, FHA vs conventional loan. A borrower may qualify for an FHA loan two years after a Chapter 7 bankruptcy discharge date. For conventional loans, the waiting period is four years from the discharge or dismissal date for a Chapter 7 bankruptcy.

For Chapter 13 bankruptcies, which involve a reorganization of one’s debts, the waiting period is four years from the dismissal date for a conventional loan. For FHA loans, a borrower may be able to qualify for an FHA loan even if still making payments under a Chapter 13 bankruptcy plan but only if those payments have been made for at least one year and there may be additional requirements such as bankruptcy trustee approval.

IX. Refinancing

The following questions should be asked as you weigh FHA vs conventional loan for refinancing:

• What’s your refinancing goal? If you’re looking for a cash-out refi but have a low credit score, then an FHA refinance may be your best option.
• What’s your current mortgage? If you currently have an FHA loan, then an FHA Streamline Refinance may be your best option. FHA streamline loans don’t require income and credit verification or an appraisal (subject to eligibility requirements).
• Do you have 20% equity? If you currently have an FHA loan and would like to eliminate your MIP, then you should consider converting your FHA loan to a conventional mortgage. However, you must have at least 20% equity (sometimes slightly more), good credit, and sufficient income among other eligibility factors.
• What’s your credit score? If you have a credit score below 680, then an FHA refinance may be best for you.