Understanding FHA Loans vs. Conventional Mortgages
FHA loans and conventional loans are the two most common ways to finance a home. FHA loans require lower down payments, as low as 3.5%, but include mortgage insurance premiums that can last for the life of the loan. Conventional loans can require as little as 3% to 5% down, and their private mortgage insurance can be removed once you build enough equity. The right choice depends on your credit score, down payment, and how long you plan to keep the loan.
What Is an FHA Loan?
An FHA loan is insured by the Federal Housing Administration. Because the government backs the lender against losses, FHA guidelines are more flexible on credit and debt:
- Down payment: 3.5% with a credit score of 580 or higher, or 10% with a score between 500 and 579 (individual lenders may set higher minimums).
- Upfront mortgage insurance (UFMIP): 1.75% of the base loan amount, which is usually rolled into the loan.
- Annual mortgage insurance (MIP): paid monthly, typically somewhere around 0.15% to 0.75% of the loan per year depending on loan size, term, and down payment. HUD sets these rates and can change them.
- How long MIP lasts: with less than 10% down, annual MIP generally lasts for the life of the loan. With 10% or more down, it typically ends after 11 years.
- Loan limits: FHA sets maximum loan amounts by county, which may be lower than conventional limits in higher-cost areas.
What Is a Conventional Loan?
A conventional loan isn’t insured by a government agency. Most follow guidelines set by Fannie Mae and Freddie Mac:
- Down payment: as low as 3% through certain first-time buyer programs. Many buyers put down 5% to 20%.
- Credit: usually a minimum score around 620, with better pricing at higher scores.
- Private mortgage insurance (PMI): required with less than 20% down, priced on your credit score and down payment, often roughly 0.3% to 1.5% of the loan per year.
- PMI removal: you can request cancellation at 80% loan-to-value, and it ends automatically at 78% of the original value on schedule. No refinance needed.
Side-by-Side Comparison
| FHA | Conventional | |
|---|---|---|
| Minimum down payment | 3.5% (580+ credit) | 3%–5% (program dependent) |
| Typical minimum credit score | 500–580 | About 620 |
| Upfront mortgage insurance | 1.75% of loan | None |
| Monthly mortgage insurance | Annual MIP | PMI if under 20% down |
| Can mortgage insurance be removed? | Often only by refinancing (if under 10% down) | Yes, at 78%–80% loan-to-value |
| Debt-to-income flexibility | More flexible | Somewhat stricter |
| Property standards | FHA appraisal requirements | Standard appraisal |
Example: A $300,000 Home
To isolate the effect of mortgage insurance, here are both loans at the same 6.5% rate on a 30-year term (your actual rates will differ):
- FHA, 3.5% down: the base loan is $289,500. Adding the 1.75% upfront premium (about $5,066) brings it to roughly $294,566. Principal and interest are about $1,862, plus annual MIP of about $133 a month at a 0.55% rate, for roughly $1,995 before taxes and insurance.
- Conventional, 5% down: the loan is $285,000. Principal and interest are about $1,801, plus PMI of about $143 a month (assuming 0.6% per year), for roughly $1,944 before taxes and insurance.
The monthly gap looks modest, but the long-term difference can be large. The conventional borrower’s PMI drops off once they reach about 22% equity. The FHA borrower in this example keeps paying MIP until they refinance or sell.
When an FHA Loan Makes Sense
- Your credit score is below about 680, where conventional PMI gets expensive or approval is harder.
- You have a small down payment and a higher debt-to-income ratio.
- You expect to refinance into a conventional loan once your credit and equity improve.
When a Conventional Loan Makes Sense
- Your credit score is strong (roughly 700 or higher), which keeps PMI affordable.
- You can put down 5% or more, or close to 20% to avoid PMI entirely.
- You plan to keep the home and loan for many years and want mortgage insurance to disappear on its own.
Final Thoughts
Ask lenders for Loan Estimates on both loan types using the same price and down payment, then compare the monthly payment, cash to close, and how long mortgage insurance will last. Run both scenarios in our mortgage calculator and check your budget with the affordability calculator to see which one fits.
