Financing a home can be a complicated process that is sometimes difficult to understand. There are many different types of loans, and the differences between them are not always obvious. FHA loans have a reputation as being a “first time home buyer” loan, while conventional financing is often thought of as something you do once you are more established. However, FHA and conventional mortgage loans are not so cut and dry, and picking one due to these misconceptions can mean that you end up with a more expensive loan. 

FHA loans are backed by the Federal Housing Administration, and are easier to qualify for if you have questionable credit, or little in savings. Conventional mortgage loans are typically a better option if you have excellent credit, but not always. Each type of mortgage loan has pros and cons, and each financial institution will have their own terms, so you will probably have to do some shopping around before you come to a final decision. 

Credit Scores 

FHA loans are more accessible than other types of mortgage loans, and you can qualify with a credit score as low as 500 (if you can find a lender). FHA loans are typically the mortgage option people choose when they are unable to qualify for other types of financing. This doesn’t mean that if you have good credit an FHA loan is a bad choice, however, as you may find that you can get better interest rates, or that your total amount owed over the life of the loan is less with an FHA loan. It all depends on the mortgage loans you qualify for, and each particular lender. 

Conventional mortgage loans typically require a credit score of at least 630, with scores over 700 being preferable. This means that for some, they are not able to get a conventional mortgage due to circumstance. 

Down Payment 

The minimum down payment for an FHA loan is 3.5%, but your credit score must be 580 or higher in order to qualify; otherwise, you will be required to have a down payment of at least 10%. Your down payment for FHA loans also determines how long you will pay mortgage insurance. With 3.5% down you pay mortgage insurance over the life of the loan (or until you refinance), but if you are able to put 10% down, you pay mortgage insurance for 11 years. 

With a conventional financing option, down payment requirements can vary widely, with the minimum being 3%. However, in order to qualify for such a low down payment, you will need good credit and a significant amount of money in savings. It is much more common to have larger down payments with conventional loans, since you usually don’t need to pay for mortgage insurance if you put at least 20% down. 

Mortgage Insurance 

FHA loans have what’s called a mortgage insurance premium, or MIP, while conventional loans have private mortgage insurance, or PMI. With an FHA loan, you will usually (but not always) pay more for mortgage insurance, since with lower down payments, it is paid over the entire lifetime of the loan. With a down payment of at least 10%, you will pay your mortgage insurance premium for 11 years, or until you refinance. 

Conventional loans have private mortgage insurance that is typically much less expensive than the MIP required for FHA loans. Private mortgage insurance is also only required until you have 20% equity in your home. 

While FHA loans have a fixed mortgage insurance rate no matter what your credit rating, private mortgage insurance for conventional loans varies based on your credit score and qualifications. 

Property Requirements 

FHA loans have detailed property requirements that are more rigorous than what is needed for a conventional loan. FHA loans can only be used for a primary residence, and you must move in within 60 days of closing. Conventional loans can be used to purchase other types of properties, such as investment properties, vacation homes, or land that you don’t want to build on for a while. 

FHA loans can also be used to finance improvements to the property you are buying, depending on the type of FHA loan you choose. This is convenient if you want to have a set payment every month, or if you need to make large energy improvements, such as installing a new HVAC system. 

Other Qualifications 

Even if you have good credit and savings, you may not qualify for a conventional loan because of your debt to income ratio. FHA loans allow for a high debt to income ratio (up to 50%), while conventional loans typically have tougher requirements.  

Refinancing Options 

FHA loans are very easy to refinance, since there are no credit checks and you don’t have to provide proof of your income. The downside is that there are strict requirements for some of the refinancing options. Once you have 20% equity, it’s a good idea to refinance so that you no longer have to pay the mortgage insurance. 

Conventional financing options can be slightly more complicated, with financial institutions typically running credit checks and verifying your income. You may not qualify for a better rate depending on how much your financial situation has changed since taking out your original loan. 

Which Option is Right for Me? 

While FHA loans are more accessible for people who don’t have the best credit scores or a lot of money saved, they can also be a great option if you have good credit but a high debt to income ratio. Conventional financing is usually best if you have excellent credit and a healthy savings account. 

FHA loans are also a good option if you need to finance large improvement projects for your home, and you only want to take out one loan. Conventional financing is the way to go if you are purchasing anything other than a primary residence you will move into immediately.