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FHA or Conventional Loan? Go Conventional If You Qualify, Experts Say

A photo to accompany a story about FHA loans vs. conventional loans FG Trade/Getty Images
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Before the current housing boom, a mortgage preapproval letter in hand and a reasonable offer were enough to submit a winning bid on a new home. 

That’s not the case today, when there are more buyers than there are homes to go around. With the fierce competition and bidding wars common among home buyers, the type of home loan you choose has become more important than ever. 

While conventional loans are always a popular option, FHA loans are easier to qualify for if you have less-than-perfect credit. But you may find it more challenging to land the home of your dreams with an FHA loan in today’s market. 

“Sellers are very leery of accepting FHA loans these days because of requirements that may come up and the appraisal addendum that comes with it,” says Brian Chinn, a Realtor and team leader with The Brian Chinn Team at eXp Realty.

Still, it’s good to explore your options and consult with a mortgage professional before deciding on a loan product. It’s possible to purchase a home that works for you with the right real estate professional and lender on your side, regardless of the loan type. 

Here’s what you need to know about FHA and conventional loans before speaking with potential lenders. 

What’s the Difference Between an FHA and Conventional Loan?

Conventional loans are popular mortgage products backed by private lenders. FHA loans are offered by approved lenders and backed by the Federal Housing Administration (FHA), a division of the U.S. Department of Housing and Urban Development (HUD). 

Lenders generally impose more stringent qualification criteria for conventional loans to protect their financial interests. Compared to an FHA loan, there’s less of a safety net for the lender to fall back on if the borrower defaults, which means the lender will have to absorb the loss. 

“Overall, FHA loans may have more rigid property standards and require a higher down payment, while conventional loans allow a lower down payment but higher credit score to get started,” says Bill Lyons, CEO of Griffin Funding.

With an FHA loan, you’ll be on the hook for mortgage insurance. You can avoid mortgage insurance on a conventional loan by putting at least 20% down or canceling it once you have 20% in home equity. 

Pros and Cons of Conventional Loans

Pros

  • Low down payment

  • Mortgage insurance is not required with a down payment of 20% or higher

  • Can be used to purchase a primary residence, vacation home, or investment property

Cons

  • Higher credit score required

  • Adverse credit history could lead to denial

Pros and Cons of FHA Loans

Pros

  • Available to borrowers with less-than-perfect credit

  • Low down payment

  • Shorter waiting period for borrowers with past foreclosures and bankruptcies

Cons

  • Purchase price capped at the local limit

  • Requires upfront mortgage insurance

  • Only covers purchases, new construction, and renovations on your primary residence

FHA Loan Limits vs. Conventional Loan Limits

Loan limits specify the maximum amount you can borrow for a mortgage under a particular loan program. They’re determined by the county of residence and number of units, and higher-cost areas tend to have more generous loan limits. These values also change annually, depending on home values.

Below are the conventional and FHA loan limits for 2022. Many areas have limits that fall between the lower figure and the high-cost area figure. 

FHA

  • Single family homes: $420,680 ($970,800 for high-cost areas)
  • Duplex: $538,650 ($1,243,050 for high-cost areas) 
  • Triplex: $651,050 ($1,502,475 for high-cost areas) 
  • Four-unit property: $809,150 ($1,867,275 for high-cost areas) 

If you live in Alaska, Hawaii, Guam, or the U.S. Virgin Islands, FHA loans are capped at the following amounts: 

  • Single-family homes: $1,456,200
  • Duplex: $1,864,575
  • Triplex: $2,253,700
  • Four-unit property: $2,800,900

Conventional 

  • Single-family homes: $647,200 ($970,800 in high-cost areas) 

FHA vs. Conventional Loan Requirements

Loan requirements are in place to help lenders determine if you’re a good fit for a mortgage. Generally, you’ll need to have a certain credit score and down payment, a steady source of income, acceptable work history, and a debt-to-income (DTI) ratio that doesn’t exceed a specific percentage. 

FHA

  • Minimum credit score: 580 (or 500 with down payment of at least 10%)
  • Minimum down payment: 3.5%
  • Maximum DTI: 43%
  • Work history: Two years of steady, verifiable employment

Conventional 

  • Minimum credit score: 620
  • Minimum down payment: 3%
  • Maximum DTI: 45% to 50%
  • Work history: One year of steady, verifiable source of income 

Mortgage Insurance for FHA Loans vs. Conventional Loans

Mortgage insurance protects the lender if the borrower defaults on the loan. It’s referred to as mortgage insurance or MIP on FHA loans. You’ll pay an upfront mortgage insurance payment for 1.75% of the loan amount at closing and also a monthly mortgage premium between 0.45% and 1.05% of the loan’s principal balance. But if you make a down payment of at least 10%, mortgage insurance premiums will fall off after 11 years, or you can refinance into a new loan and put 20% down. 

Borrowers who take out conventional loans also pay private mortgage insurance, or PMI, but only if the down payment is below 20%. The cost for PMI can range between 0.58% and 1.86% of the loan amount annually in premiums.

When Does a Conventional Loan Make Sense?

A conventional loan gives you the best chance of getting your offer accepted, given the competitive nature of the current housing market. 

“Conventional loans are more favorable in the eyes of a seller. Many times, conventional offers will be accepted over FHA due to the conventional borrower having a higher credit score, as well as looser appraisal guidelines,” says Mandy Phillips, branch manager at Vista Home Loans

Pro Tip

If you can qualify for a conventional loan, that might be a better choice than an FHA loan in a competitive housing market, as sellers often prefer buyers with conventional mortgages.

If you’re leaning towards an FHA loan to keep more money in your pocket after the down payment, you may get the same luxury with a conventional loan. 

“People don’t realize that you can get as low as 3% down payment for first-time homebuyers, which is lower than FHA,” Chinn says. “A conventional loan is not frowned upon by sellers like an FHA loan is. If a homebuyer can do a conventional loan, they shouldn’t ever go the FHA route. Sometimes lenders will point well-qualified individuals to an FHA loan because they make more money on FHA loans than on conventional loans. It costs the consumer more.”    

When Does an FHA Loan Make More Sense?

The lending standards for FHA loans are more flexible, making them a better fit for borrowers who can’t qualify for a conventional loan. 

“FHA loans have a lower credit score requirement than conventional loans and a shorter waiting period for negative credit items. The post-foreclosure waiting period is only three years. Some borrowers who file bankruptcy only have to wait two years or only one in some circumstances,” Phillips says. 

There’s also more leniency for borrowers with higher debt loads. “In some instances, lenders allow borrowers to have a maximum DTI of 56.99%,” Phillips says.