When shopping for a mortgage, knowing what specific type of loan is best for you is important.
Mortgages are divided into two main categories: Conventional loans and government-backed loans. And there are meaningful differences between the two.
Loans that are guaranteed by the government are generally easier to qualify for if you have less-than-perfect credit. But these loans usually have extra fees and restrictions, so conventional loans can be more affordable and easier to understand.
Understanding the benefits and drawbacks of each type of mortgage will help streamline the process of finding the best mortgage. So before you start comparing lenders, mortgage rates and fees, here’s what you need to know about conventional loans and government-secured mortgages, such as FHA loans and VA loans.
Conventional vs. FHA vs. VA loans
|Conventional Loans||FHA Loans||VA Loans|
|Minimum Credit Score||620||500 with 10% down; 580 with 3.5% down||No minimum score|
|Loan Limits||$647,200 to $970,800 for conforming loans||$420,680 to $970,800 for single-family homes||No loan limits|
|Down payment Minimum||3%||3.5%||No down payment required|
|Extra Fees||PMI required with down payment of less than 20%||Upfront mortgage insurance of 1.75% and ongoing fee of 0.45% to 1.05%||Upfront funding fee of 1.4% to 3.6%|
What’s a Conventional Loan?
A conforming loan is one that meets or conforms to, the Federal Housing Finance Agency’s (FHFA) conforming loan limits. The maximum loan limits vary by region, and property type. This cap is adjusted every year, and in 2022 the limit for single-family homes is $647,200 to $970,800.
Conventional loans are one of the most popular types of mortgages. Nearly all home loans that aren’t backed by a federal agency are conventional mortgages. There are two main types of conventional mortgages: Conforming and non-conforming, or jumbo loans.
Any mortgage that exceeds the maximum loan limit is considered a jumbo loan, or non-conforming loan. Jumbo loan rates tend to be higher than conforming loans, and these types of mortgages usually require larger down payments.
Because they aren’t insured by the government, conventional loans typically have more strict borrower standards for things like your credit score and debt-to-income ratio. “Generally speaking, conventional loans are designed for people who have higher credit scores and enough money for a down payment,” says Andrina Valdes, chief operating officer at Cornerstone Home Lending. However, certain conventional mortgages require as little as 3% down. But if you have a down payment of less than 20% you’ll usually be required to pay private mortgage insurance (PMI), which you can later get rid of PMI once your loan-to-value ratio reaches 80%.
What’s an FHA Loan?
FHA loans are mortgages that are issued by a traditional mortgage lender and insured by the Federal Housing Administration, which is part of the U.S. Department of Housing and Urban Development (HUD). These mortgages are issued by private FHA-approved lenders. Many of the most popular types of lenders — such as banks, credit unions, and brokers — offer FHA loans.
FHA loans are typically easier to obtain because they’re considered less risky by lenders. The minimum credit score required for an FHA mortgage is 500 to 580 depending on the size of your down payment. However, that’s the FHA’s loan requirements and mortgage lenders have what are known as overlays.
An overlay is an additional requirement imposed by a lender beyond what the government requires. “Most of the major banks won’t touch an FHA loan unless the credit score is 620 or above,” says David Dye, broker, and owner of the Southern California-based GoldView Realty. So while it’s technically possible to get an FHA loan with a credit score of 500, you could still have a hard time finding a lender.
FHA loans also require that you pay a few additional fees that you can avoid with a conventional loan. When you take out an FHA mortgage, you’ll pay a 1.75% upfront mortgage insurance premium (MIP). Also, each month you’ll pay mortgage insurance payments of 0.45% to 1.05% of your annual loan balance.
The upfront MIP fee can be added to your loan amount at closing and in some cases, you can eventually waive the monthly insurance payments. If your down payment was less than 10% when you took out the loan, you’re required to pay for mortgage insurance for the entire loan term. But with a down payment of 10% or more, you can waive MIP payments after 11 years.
What’s a VA Loan?
As a benefit to military veterans, the U.S. Department of Veterans Affairs guarantees certain home loans for eligible veterans. These are known as VA loans and are similar to FHA loans in that the Department of Veterans Affairs doesn’t issue most of these loans, but instead just insures them.
To qualify for a VA loan, you need to be one of two things: a veteran who meets the service requirements, or a surviving spouse of a veteran. In many cases, being on active duty for at least 90 days will qualify you for a VA loan. However, the eligibility requirements are different depending on when you served and for members of the National Guard.
One of the biggest advantages of a VA loan is that you can finance 100% of the home’s cost. Not having to come up with a sizable down payment in addition to thousands of dollars in closing costs makes a home purchase much more affordable, especially for first-time homebuyers.
And while the VA doesn’t set a minimum credit score requirement for VA loans, there are still overlays from lenders. “Some lenders may be okay with a credit score of 500, but most will require 580 to 640,” Dye says.
The biggest drawback to VA loans is that they have a unique upfront fee known as the VA funding fee. This fee is a percentage that’s based on whether it’s your first time getting a VA-backed mortgage and the percentage of your down payment. So this fee varies from 1.4% to 3.6% of the loan amount, and it is possible to roll the fee into your initial loan balance. Under limited circumstances a borrower can qualify for a funding fee waiver. In most cases, there are no loan balance limits for VA loans.
Conventional loans can be cheaper than other loans. You won’t pay a VA funding fee, and if you can afford a 20% down payment, you won’t pay mortgage insurance.
Which Mortgage Type Is Best for You: VA, FHA, or Conventional?
The best type of mortgage for you will depend heavily on what loans you qualify for. But just because you’re eligible for a particular loan, like a VA loan, that doesn’t mean it’s always the best choice.
Broader market factors also play a role. Right now, housing inventory is exceptionally low, which has created bidding wars for homes and increased prices. In this type of market that favors sellers, real estate agents and sellers usually prefer offers that are financed with a conventional loan. This is because there’s a commonly held perception that government-backed loans are more difficult to work with. “Some sellers don’t like VA financing because there are certain fees that the veteran isn’t allowed to pay,” Valdez says.
So if you can qualify for a conventional loan, then that will give you the best chance of having your offer accepted in today’s market. And if you can manage a down payment of 20%, that’s even better because you’ll avoid having to pay PMI. For homebuyers in this scenario, conventional loans are often the cheapest type of financing.
If you’re a qualifying veteran, VA loans provide a path to homeownership without requiring a borrower to provide a down payment. “A VA loan is a great loan for a first-time homebuyer who has been a veteran and they don’t have a lot of cash to put into the transaction,” Valdez says. This gives borrowers the opportunity to become a homeowner without draining their emergency fund or retirement account. And if you qualify for a VA funding fee waiver, then a VA mortgage can easily be the most affordable type of mortgage.
FHA loans are a good option for borrowers who aren’t eligible for the other types of mortgages because the lending standards are less strict. For example, FHA loans are more lenient with your employment history, Dye says. And FHA-backed mortgages are more flexible when it comes to issues with your credit history. You may be able to qualify for a loan in as little as one or two years after a bankruptcy filing. And even though you’ll pay mortgage insurance on an FHA loan, if you have poor credit you’ll likely pay much less than you would with a conventional mortgage. With an FHA loan, the maximum insurance premium is 1.05% and having a low credit score won’t increase the payment. The PMI on a conventional loan can cost more and your credit score factors into what you pay.