What is the Difference Between an FHA Loan and a Conventional Loan?
Learn about the key differences between FHA and conventional loans, and find out which one may be right for you.
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FHA Loan Basics
FHA loans are government-backed loans that are available to borrowers who may not have perfect credit or a large down payment. FHA loans are a good option for first-time homebuyers and those with low credit scores. Conventional loans are not backed by the government and typically have stricter credit requirements.
The main difference between FHA and conventional loan requirements is that the federal government insures mortgages with looser qualifying standards to make it possible for first-timers to achieve the American dream-to buy a home. An FHA loan have more lenient credit standards and tends to be more forgiving about credit history with regard to bankruptcies or foreclosures.
Mortgage insurance protects the lender or the owner of a mortgage loan in the event of a default on the loan. Mortgage insurance is required on all FHA loans and on conventional loans with down payments less than 20 percent.
There are two types of mortgage insurance: private mortgage insurance (PMI) and Mortgage Insurance Premiums (MIP). PMI is insurance that is provided by a private company, and MIP is insurance that is provided by the government.
Private mortgage insurance is required on all conventional loans with down payments less than 20 percent. The monthly premium for PMI varies, depending on the amount of the down payment, the term of the loan, and the credit score of the borrower.
Mortgage Insurance Premiums are required on all FHA loans. The monthly premium is based on the loan amount, the term of the loan, and the Loan-to-Value ratio. The Loan-to-Value ratio is the amount of the loan divided by the value of the property. For example, if you are buying a $100,000 house with a $10,000 down payment, your Loan-to-Value ratio would be 10%. You would pay $80 per year for every $1000 financed in mortgage insurance premiums.
FHA Loan Limits
Loans insured by the Federal Housing Administration (FHA) can be made for as little as 3.5% down and have relatively flexible credit score requirements. In 2019, the standard FHA loan limit for a single-family home in most areas of the U.S. is $314,827; in high-cost areas, the limit is $726,525. That’s up from $294,515 and $679,650, respectively, in 2018. (These limits are subject to change each year.)
To qualify for an FHA loan with a 3.5% down payment, you’ll need a credit score of at least 580. Borrowers with credit scores between 500 and 579 are required to make a 10% down payment. Remember that your credit score is just one factor that lenders will consider when determining whether or not to give you a loan; other factors include income level and employment history.
Conventional Loan Limits
A conventional mortgage is one that’s not guaranteed or insured by the federal government in any way—private lenders assume all of the risk when you take out this type of loan. That means that if you stop making your payments (for any reason), the lender can come after your home—and conventional loans typically have stricter provisions for this than government-backed loans do.
For 2019, the conforming loan limit for most single-family homes across the U.S. (except in high-cost areas) is $484,350; in high-cost areas, it’s $726,525.(These limits are subject to change each year.)
Conventional Loan Basics
A conventional loan is a mortgage that is not backed or insured by the government, such as the Federal Housing Administration (FHA) or the Department of Veterans Affairs (VA). A conventional loan can be a great option if you have a good income and credit history and are able to make a large down payment.
The minimum down payment for an FHA loan is 3.5%. The minimum down payment for a conventional loan is 5%.
Conventional loans usually require that the borrower pay for private mortgage insurance (PMI) if the down payment is less than 20%. PMI is insurance that protects the lender in case the borrower defaults on the loan. With a conventional loan, the lender is protected against loss if the borrower fails to make payments on their mortgage.
With an FHA loan, the borrower is required to pay for mortgage insurance, but this insurance is provided by the government rather than a private company. Mortgage insurance on an FHA loan is paid for by the borrower and allows lenders to offer loans to borrowers who might not otherwise qualify for a conventional mortgage.
Conventional loans are not guaranteed by the federal government but they may be obtained from private lenders, such as banks, credit unions, and mortgage companies. The loans are available in a variety of terms, with the most common being 30-year and 15-year fixed-rate mortgages.
The main difference between an FHA loan and a conventional loan is that an FHA loan is insured by the federal government, whereas a conventional loan is not. If a borrower defaults on an FHA loan, the lender is protected against loss by the federal government. If a borrower defaults on a conventional loan, the lender bears the full risk of loss.
Loan limits are another key difference between FHA loans and conventional loans. The maximum loan limit for an FHA loan in most parts of the country is $625,500. The maximum loan limit for a conventional loan varies from county to county, but is generally $484,350 for a one-unit property. Higher limits may be available for properties with more than one unit (e.g., two-unit, three-unit, etc.), as well as for higher-priced areas of the country.
The Bottom Line
It really comes down to credit score when you’re trying to determine the difference between an FHA loan and a conventional loan. An FHA loan is a mortgage that’s backed by the Federal Housing Administration, which is part of the U.S. Department of Housing and Urban Development (HUD). A conventional loan isn’t backed by any government agency.
The main difference between an FHA loan and a conventional mortgage is that an FHA loan is insured by the government, while a conventional loan is not. If you default on an FHA loan and your house isn’t worth enough to cover the debt, the FHA will pay the lender the difference.
With a conventional mortgage, you only get private mortgage insurance (PMI) if you put down less than 20%. So if you buy a $200,000 home with a 10% down payment, you’ll have to get PMI. But with an FHA loan, you only need 3.5% for a down payment, and PMI is automatically included in your payment. So if you buy a $200,000 home with a 3.5% down payment, your monthly payment will be $966 ($741 for principal and interest, plus $225 for mortgage insurance).
Both FHA loans and conventional loans usually require at least 3% down (or higher), so they are not technically low-down-payment loans — but because they usually allow lower credit scores and/or lower incomes than other types of mortgages, they can make homeownership possible for millions of people who otherwise might not qualify.