FHA vs Conventional Loan
Low Down Payment Home Loans
Of the four major mortgage loan programs, FHA and conventional are the most popular. They are essentially available to anyone who qualifies and are offered in all 50 states, D.C., and U.S. territories.
The remaining two options, VA and USDA, offer no down payment mortgage loans. However, they are only available to those who meet eligibility requirements. If you are in the military, a veteran, or looking for a home in a less populated area, it's worth it to explore VA loans and/or USDA loans.
Explore Down Payment Options
| Loan Type | Min. Down | Link |
|---|---|---|
| Conventional | 3% | Mortgage Calculator |
| FHA | 3.5% | FHA Calculator |
| VA | $0 | VA Calculator |
| USDA | $0 | USDA Calculator |
Brief Synopsis of FHA and Conventional Home Loans
There are several aspects of FHA and conventional home loans that need to be observed when determining which option is right for you. The following items differ between the two loans and impact decision making.
- Down Payment
- Interest Rate
- Mortgage Insurance
- Duration of Mortgage Insurance
- Credit Score Impact on Interest Rate and Mortgage Insurance
Conventional Loan
A conventional mortgage is traditionally what homeowners have used to purchase a home. Conventional loans are comparatively simplistic. If you've ever heard the terms Fannie Mae and/or Freddie Mac, those are entities that regulate conventional loans. They provide guidelines for banks and mortgage lenders to adhere to in order to continue originating conventional mortgage loans.
Originally, most conventional loans included 20% down payments. However, conventional loans now permit as little as 3% down as long as the mortgage has protection in place in the form of mortgage insurance. Conventional mortgage insurance is referred to as PMI and is covered later.
For purposes of comparing conventional loans with FHA, 3% and 5% down payments are the most relevant. If you are making a traditional 20% down payment, there are few scenarios where FHA makes sense. If you are unsure about your down payment, our down payment calculator is helpful.
FHA Loan
FHA loans are the most popular low down payment mortgage loans. The Department of Housing and Urban Development (HUD) is a government organization that oversees the FHA loan program. The program is funded by FHA's own versions of mortgage insurance, similar to conventional loans with less than 20% down payments.
FHA loans require only a 3.5% down payment and can offer more favorable underwriting criteria than conventional loans. The smaller down payment requirement makes FHA loans popular with first-time homebuyers.
Comparing FHA and Conventional Loans
The most common mortgage is the 30-year fixed rate loan. All examples use those parameters.
Down Payment
The easiest, most straightforward difference to compare is down payment. While you can always put more down than the minimum, most homebuyers using FHA will go with 3.5%. Alternatives for those buyers are 3% and 5% down payment conventional loans, respectively.
| Down Payment | |||
| Purchase Price | FHA | 3% Conv. | 5% Conv. |
|---|---|---|---|
| $150,000 | $5,250 | $5,000 | $7,500 |
| $420,680 | $14,724 | $12,621 | $21,034 |
$420,680 is the base FHA loan limit. Higher limits are available in certain areas.
The lower the purchase price, the lower the gap between the various down payments. Obviously, 3% is always going to be lower than 3.5% or 5%. So why would anyone choose FHA or 5% down when 3% is available?
Interest Rate
FHA interest rates are low. They are almost always lower than a comparable conventional loan. FHA loans are guaranteed by the federal government. Therefore, they are generally considered less risky by lenders, and the interest rate reflects that.
Even though FHA loan rates are extremely competitive, other factors must be considered.
Mortgage Insurance
Where down payment is easy to understand, mortgage insurance is likely the most complex.
FHA mortgage insurance (MIP) is essentially fixed*, which is to say it is the same for everyone who makes a 3.5% down payment and chooses a 30-year term. FHA buyers have an upfront premium of 1.75% of their loan amount added to their FHA loan. Additionally, they'll pay an annual fee monthly as part of their house payment.
*15-year terms and larger down payments can reduce FHA MIP.
FHA Mortgage Insurance Examples
| Purchase Price | FHA Base Loan | Upfront MIP | Annual MIP |
|---|---|---|---|
| $150,000 | $144,750 | $2,533 | $102 /mo |
| 420,680 | $405,956 | $7,104 | $285 /mo |
Private Mortgage Insurance (PMI)
FHA MIP is a tremendous factor that drives homebuyers to low down payment conventional loans. However, PMI on conventional loans can vary from loan to loan depending on the borrower's loan profile.
Credit score does not impact FHA MIP. It is the same for all borrowers. Since conventional PMI is issued by a private company (not a government agency), the price is risk-based. The less risk of default given a buyer's application, including debt-to-income ratio, down payment percentage, and credit score, the lower the PMI should be.
Conventional PMI rates vary dramatically. They are computed similarly as FHA annual MIP but with a wide range of values. Borrowers with little debt, larger down payments, and high credit scores will pay significantly less than borrowers without those characteristics. Low down payment conventional loans already have higher PMI rates. A lower credit score and high debt-to-income ratio will increase the PMI amount even further.
FHA MIP vs PMI
A gigantic difference between PMI and FHA MIP is how long the homeowner will pay it.
FHA MIP remains part of your house payment for the life of your FHA loan. That means if you never refinance and take 30 years to pay your loan off, you'll be paying mortgage insurance the entire time. This is a major drawback to FHA loans.
However, in reality, most homeowners do not maintain the same mortgage loan for the duration of homeownership. As equity grows due to appreciation and paying down the loan balance, the loan profile becomes more attractive to conventional financing. Refinancing an FHA loan to a conventional loan after a few years is common.
The general rule for conventional PMI is once the loan balance becomes less than 80% of the home's value the PMI can be removed. Similarly to FHA, low down payment conventional buyers often refinance to better terms once their loan profile improves.
Keep in mind that refinancing is never guaranteed. Lending environments change, and you should be prepared to honor your obligation for the full term of your FHA or low down payment conventional loan.
Credit Requirements
If you have great credit, either loan option will likely work. FHA loans seem to have a reputation for leniency not extended to conventional loans. While this may be somewhat true, the primary advantage of FHA loans to those with suboptimal credit is the lack of "adjustments" to mortgage insurance and/or interest rate.
As previously discussed, FHA mortgage insurance is the same for everyone. However, conventional loans are priced based on risk. The worse your credit, the worse your rate. The same goes for PMI. One of the primary reasons FHA has earned its reputation is those with lower credit scores get priced out of conventional loans. At some point the adjusted premiums no longer make sense.
Regardless of credit score, borrowers requiring low down payment flexibility should explore both FHA and conventional loan options.
Conclusion
The most important takeaway when comparing FHA loans to low down payment conventional loans is that you have options. Work with a lender to discover which option is right for you. Both types of loans are extremely popular because every borrower is different. What is right for one is not always right for another. Start early by getting pre-approved with one or more lenders.
You can compare FHA loan payments to similarly structured conventional loans to get an idea of where you stand before speaking to a lender. Being aware of your options is a solid foundation on your path to becoming a homeowner.
