Understanding FHA Loans
FHA loans are mortgages insured by the Federal Housing Administration. Because the government backs these loans, lenders are willing to extend credit to borrowers who might not qualify for conventional financing. Key characteristics of FHA loans include:
- Minimum credit score of 580 for 3.5% down payment; 500-579 requires 10% down
- Down payment as low as 3.5% — one of the lowest available
- Higher debt-to-income ratios permitted — up to 43% (sometimes 50% with compensating factors)
- Upfront MIP of 1.75% of the loan amount, usually rolled into the loan
- Annual MIP ranging from 0.45% to 1.05% paid monthly, for the life of the loan in most cases
- Loan limits set by county — FHA loans cannot exceed conforming limits
- Property standards — FHA appraisers check for safety and habitability issues
Understanding Conventional Loans
Conventional loans are not government-backed — they conform to standards set by Fannie Mae and Freddie Mac. They require stronger credit and typically larger down payments, but offer significant long-term cost advantages for qualified borrowers.
- Minimum credit score of 620, though rates improve dramatically above 740
- Down payment as low as 3% (Fannie Mae HomeReady, Freddie Mac Home Possible)
- Standard DTI limit of 45%, sometimes higher with strong compensating factors
- PMI required if down payment is less than 20%, but it is cancellable at 20% equity
- No upfront mortgage insurance premium
- Conforming loan limits ($766,550 in most areas for 2024; higher in high-cost areas)
- No property condition restrictions beyond standard appraisal requirements
Head-to-Head Comparison
| Factor | FHA Loan | Conventional Loan |
|---|---|---|
| Minimum Credit Score | 580 (3.5% down) / 500 (10% down) | 620 minimum; 740+ for best rates |
| Minimum Down Payment | 3.5% (with 580+ score) | 3% (special programs); 5% standard |
| Mortgage Insurance | Required for life of loan (usually) | PMI; cancellable at 20% equity |
| Upfront Insurance Cost | 1.75% UFMIP | None |
| Annual Insurance Rate | 0.55-1.05% of loan balance | 0.20-1.50% (varies by credit/LTV) |
| DTI Limit | Up to 50% with compensating factors | 45-50% maximum |
| Property Requirements | Strict safety/habitability standards | Standard appraisal requirements |
| Loan Limits | FHA county limits | Conforming limits; jumbo above |
| Best For | Lower credit, less savings | Good credit, long-term cost savings |
When to Choose FHA
An FHA loan is generally the better choice when:
- Your credit score is below 620 — FHA is often your only option
- You have minimal savings and need the lowest possible down payment
- You have had past credit challenges like a bankruptcy or foreclosure (FHA has shorter waiting periods)
- Your income is irregular or you have a high debt-to-income ratio
- You are buying a home that needs repairs (using an FHA 203k renovation loan)
When to Choose Conventional
A conventional loan is generally the better choice when:
- Your credit score is 740 or above — you will get conventional loan pricing advantages
- You have or can save 20% for a down payment (eliminates PMI entirely)
- You are buying a condo or investment property (FHA has restrictions)
- You want to cancel mortgage insurance once you build equity
- The purchase price exceeds FHA loan limits in your area
- You want to avoid the FHA upfront mortgage insurance premium
The Long-Term Cost Reality
A borrower with a 720 credit score who chooses FHA will pay the 1.75% upfront MIP plus ongoing annual MIP that — unlike conventional PMI — does not automatically cancel. Over 30 years on a $300,000 loan, this can add $30,000+ to total loan costs versus a conventional loan with the same borrower. Run the numbers carefully before choosing.