How Is an FHA Loan Different From a Conventional Loan?

Navigating home financing can be overwhelming, with many options available to prospective homeowners. Understanding the distinctions between different mortgage types is an important step in making an informed financial decision. FHA loans and conventional loans are two of the most common options. While both help individuals purchase a home, they operate under different frameworks and cater to varying financial profiles. Understanding their characteristics helps clarify which option might best align with homeownership goals.

Understanding FHA Loans

An FHA loan is a mortgage insured by the Federal Housing Administration, an agency of the U.S. Department of Housing and Urban Development (HUD). This government backing protects lenders against borrower default, allowing them to offer more lenient qualification criteria. FHA loans are particularly beneficial for first-time homebuyers or those with less-than-perfect credit histories or limited funds for a down payment.

To qualify for an FHA loan, borrowers generally need a credit score of at least 580 to be eligible for the minimum 3.5% down payment. If a borrower’s credit score falls between 500 and 579, a 10% down payment is typically required. While the FHA sets these minimums, individual lenders may implement slightly higher credit score requirements.

Debt-to-income (DTI) ratios are also considered, with many lenders preferring a DTI of 43% or less, though some may accept higher ratios, potentially up to 55% with compensating factors. FHA loans mandate a Mortgage Insurance Premium (MIP), which includes both an upfront payment and an annual premium. The upfront MIP is 1.75% of the loan amount, which can be paid at closing or financed into the loan, while the annual MIP is paid monthly.

Property standards are also a consideration for FHA loans. The home must meet specific safety, security, and structural soundness requirements. An FHA-approved appraiser evaluates the property to ensure it complies with HUD’s minimum property standards, checking for issues like structural defects and functional major systems. This appraisal helps protect both the borrower and the lender from properties with significant physical damage or health hazards.

Understanding Conventional Loans

Conventional loans are backed by private lenders such as banks, credit unions, and mortgage companies. These loans often adhere to guidelines set by government-sponsored enterprises (GSEs) like Fannie Mae and Freddie Mac. Conventional loans are widely popular and suitable for borrowers with stronger financial profiles.

Eligibility for a conventional loan involves higher credit score expectations compared to FHA loans. Most lenders require a minimum credit score of 620, though a score of 680 or higher may result in more favorable terms and interest rates. Down payment options are varied, though a 20% down payment is commonly advised to avoid private mortgage insurance.

Lenders also assess the borrower’s debt-to-income ratio, preferring it to be 43% or lower, although some may approve DTI ratios up to 50%. When a down payment of less than 20% is made on a conventional loan, borrowers are required to pay Private Mortgage Insurance (PMI). PMI protects the lender in case of default and is an additional monthly cost.

Unlike FHA’s Mortgage Insurance Premium, PMI on conventional loans can be removed once the borrower reaches sufficient equity in their home. PMI can be canceled when the loan-to-value (LTV) ratio reaches 80% of the original home value, either through principal payments or increased home value. Lenders are also required to automatically terminate PMI once the LTV reaches 78% of the original value, provided the borrower is current on their payments.

Key Distinctions

A primary difference between FHA and conventional loans lies in their down payment requirements. FHA loans permit lower minimum down payments, as low as 3.5% for borrowers with a credit score of 580 or higher. Conventional loans can also offer low down payment options, as little as 3%, but often require a 5% or 10% minimum.

Credit score considerations also vary significantly. FHA loans are designed to be more accessible, allowing for lower credit scores, with some lenders accepting scores down to 500 with a larger down payment, or 580 for the minimum 3.5% down. Conventional loans demand higher credit scores, with most lenders setting a minimum of 620, and better terms reserved for scores of 680 and above.

The application of mortgage insurance is another notable distinction. FHA loans require a Mortgage Insurance Premium (MIP), which includes an upfront fee of 1.75% and an annual premium. For FHA loans with less than a 10% down payment, MIP is paid for the entire loan term, while with a 10% or more down payment, it’s paid for 11 years. Conventional loans, conversely, require Private Mortgage Insurance (PMI) only when the down payment is less than 20%, and PMI can be canceled once the borrower reaches 20% equity in the home.

Property standards for FHA loans are more stringent, requiring the home to meet specific health, safety, and structural soundness criteria through an FHA appraisal. Conventional loans also require an appraisal to determine market value, but their property condition requirements are less prescriptive, focusing more on the home’s value as collateral. Both loan types have limits on the maximum amount that can be borrowed. FHA loan limits are set by the government, varying by county. Conventional conforming loan limits, set by Fannie Mae and Freddie Mac, are $806,500 for most single-unit properties in 2025, with higher limits in high-cost areas.

Finally, debt-to-income ratios exhibit different levels of flexibility. While both loan types consider DTI, FHA loans allow for higher ratios, up to 55% with compensating factors, making them more forgiving for borrowers with higher existing debts. Conventional loans prefer a DTI of 43% or less, though some flexibility up to 50% might be offered.