What Is an FHA Loan vs. a Conventional Loan?

Homeownership often involves navigating various financing options, with mortgages being the most common path. Among the diverse mortgage products available, Federal Housing Administration (FHA) loans and conventional loans represent two primary categories. Understanding their fundamental differences is crucial for prospective homebuyers as these distinctions can significantly impact eligibility, costs, and long-term financial commitments.

Understanding FHA Loans

FHA loans are a type of mortgage insured by the Federal Housing Administration (FHA), which operates under the U.S. Department of Housing and Urban Development (HUD). The FHA does not directly lend money; instead, it insures loans made by FHA-approved private lenders. This government backing reduces risk for lenders, enabling them to offer more favorable terms to borrowers who might otherwise face challenges securing a mortgage. FHA loans aim to make homeownership more accessible, especially for individuals with lower credit scores or smaller down payments.

To qualify for an FHA loan, borrowers generally need to meet specific eligibility requirements. A minimum credit score of 580 typically allows for a down payment as low as 3.5% of the home’s purchase price. For those with credit scores between 500 and 579, a higher down payment of 10% is generally required. Lenders also assess the borrower’s debt-to-income (DTI) ratio, which compares monthly debt obligations to gross monthly income. FHA guidelines can be lenient, sometimes allowing ratios up to 50% or even 55% depending on other compensating factors like strong credit history or significant cash reserves.

Homes financed with an FHA loan must also meet specific property standards, verified through an FHA appraisal. These appraisals focus on ensuring the property meets minimum health, safety, and structural integrity requirements, sometimes referred to as Minimum Property Standards (MPS). Properties requiring significant repairs may not qualify until issues are addressed. Additionally, FHA loans come with mandatory mortgage insurance, including both an Upfront Mortgage Insurance Premium (UFMIP) and an Annual Mortgage Insurance Premium (MIP).

FHA loans are subject to loan limits, which vary by county and are updated annually. These limits define the maximum amount that can be borrowed through an FHA-insured mortgage. Another feature of FHA loans is their general assumability, meaning a qualified buyer can potentially take over the seller’s existing FHA mortgage, including its interest rate and terms.

Understanding Conventional Loans

Conventional loans differ from FHA loans as they are not insured or guaranteed by any government agency. These mortgages are offered by private lenders, such as banks, credit unions, and mortgage companies. The majority of conventional loans adhere to guidelines set by government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac; these are known as conforming loans. Loans that exceed these conforming limits are called non-conforming loans, with jumbo loans being a common example for higher loan amounts.

Eligibility for conventional loans typically requires a stronger financial profile compared to FHA loans. Borrowers generally need a credit score of at least 620, though higher scores are often necessary to secure the most favorable interest rates and terms. While a 20% down payment is often recommended to avoid Private Mortgage Insurance (PMI), conventional loans can be obtained with down payments as low as 3% for certain programs. Debt-to-income (DTI) ratios are also a significant factor, with conventional lenders typically preferring a maximum DTI ratio between 36% and 50%, depending on the borrower’s credit score and other financial reserves.

Private Mortgage Insurance (PMI) is a common cost associated with conventional loans when the down payment is less than 20%. This insurance protects the lender in case the borrower defaults on the loan. PMI can often be canceled once a borrower builds sufficient equity in their home. Federal law mandates automatic termination of PMI when the loan-to-value (LTV) ratio reaches 78% of the original home value, provided the borrower is current on payments. Borrowers can also request cancellation earlier, typically when their LTV reaches 80%, often requiring a good payment history and sometimes a new appraisal to confirm the property’s current value.

Conforming conventional loans are subject to loan limits set annually by the Federal Housing Finance Agency (FHFA). These loans are generally not assumable, meaning the borrower cannot typically transfer their mortgage to a new buyer. Most conventional loan contracts include a “due-on-sale” clause, which requires the loan to be paid in full upon the sale or transfer of the property.

Key Distinctions in Loan Characteristics

The fundamental differences between FHA and conventional loans become apparent when examining their specific characteristics. These include mortgage insurance, down payment requirements, credit flexibility, debt-to-income ratios, property standards, loan limits, and assumability.

Mortgage insurance represents a significant divergence between the two loan types. FHA loans require both an Upfront Mortgage Insurance Premium (UFMIP) and an Annual Mortgage Insurance Premium (MIP). The UFMIP is a one-time charge of 1.75% of the loan amount, typically financed into the loan. The Annual MIP, a monthly charge, continues for the entire loan term if the down payment is less than 10%, or for 11 years if the down payment is 10% or more.

In contrast, conventional loans with less than a 20% down payment require Private Mortgage Insurance (PMI). PMI can be canceled once the borrower reaches 20% equity in their home, either through payments or property appreciation, or it automatically terminates when the loan-to-value ratio reaches 78% of the original loan amount. This cancellability often makes PMI less costly over the life of the loan than FHA’s MIP for many borrowers.

Down payment requirements also vary considerably. FHA loans allow for a minimum down payment of 3.5% for borrowers with a credit score of 580 or higher, and 10% for those with scores between 500 and 579. Conventional loans, while offering options with as little as 3% down, generally favor a 20% down payment to avoid PMI. The flexibility of FHA loans with lower down payments can be particularly advantageous for first-time homebuyers or those with limited savings.

Credit score flexibility distinguishes FHA loans, which are designed to be more accessible to borrowers with lower credit scores, potentially as low as 500. Conventional loans typically require a minimum credit score of 620, and higher scores are often necessary to obtain competitive interest rates and to qualify for lower down payment options without excessive PMI costs.

Debt-to-income (DTI) ratios also reflect differing leniency. FHA loans tend to be more forgiving of higher DTI ratios, sometimes allowing combined ratios up to 50% or even 55% in certain situations. Conventional loans often prefer DTI ratios closer to 36% to 45%, though some automated underwriting systems may approve up to 50% for strong applicants.

Property condition standards present another notable difference. FHA loans require an FHA appraisal that specifically evaluates the property for health, safety, and structural soundness, often leading to stricter requirements for repairs before a loan can close. Conventional loan appraisals primarily focus on determining the property’s market value, and while they identify major deficiencies, they are generally less stringent about minor repairs or cosmetic issues than FHA appraisals.

Loan limits also differ in their calculation and application. FHA loan limits are set at a county level, based on median home prices, with a national floor and ceiling that vary annually. For 2025, these limits range from $524,225 to $1,209,750 for single-family homes. Conforming conventional loan limits are uniform across most of the country, with higher limits in designated high-cost areas, reaching $806,500 in standard areas and up to $1,209,750 in high-cost areas for a single-unit property in 2025. Loans exceeding these amounts fall into the non-conforming or jumbo loan category.

Finally, assumability is a key distinction. FHA loans are generally assumable, meaning a qualified buyer can take over the existing loan’s terms and interest rate. Conventional loans, by contrast, typically include a “due-on-sale” clause, which requires the loan to be paid off when the property is sold, making them generally non-assumable.