Purchasing a home is probably one of the most significant financial investments you will make. Traditionally, the only way to secure financing was to apply for a conventional mortgage with a 20% down payment and a 30-year fixed rate loan term.

Now, you have more options. Not only can you choose between different types of conventional loans, but you can also apply for a Federal Housing Administration mortgage. Find out which is right for you.

Understand the Different Types of Conventional Mortgages

Conventional mortgages are what most people think about when they think of a home loan. However, a conventional loan is not one single type of loan. There are two broad categories: conforming and non-conforming loans.

While conforming loans follow the guidelines Freddie Mac and Fannie Mae establish, non-conforming ones do not. Most people apply for conforming loans, as non-conforming loans are generally either for homes that exceed the limits of conforming loans or borrowers who don’t meet credit requirements for any other loan type (including government-backed loans).

What Are the Types of Conforming Conventional Loans?

Interest rates are a significant factor in how much you pay for your house over the life of your loan, and they are highly variable. Conventional loans can have a fixed interest rate or an adjustable interest rate.

According to Fannie Mae, fixed-rate mortgages had a 3% average rate in 2021, while five-year adjustable-rate mortgages averaged 2.6%. In 2023, projections put those rates at an average of 4.9% for fixed-rate and 4.2% for adjustable-rate mortgages.

Generally, ARMs begin with an interest rate that remains fixed for a predetermined period and then fluctuates with market changes. Fixed-rate mortgages maintain the same interest rate for the duration of the loan, which is typically 30 years but can also be 10, 15 or 20 years. Borrowers can also find the following options for fixed-rate mortgages:

• Conventional 95: These conventional loans allow you to put 5% down on your new home. They require you to have mortgage insurance, which adds to your monthly payment costs.

• Conventional 97: Instead of paying a 5% down payment, these loans only require 3%. As with the Conventional 95, you need mortgage insurance with these loans.

• Piggyback: This type of loan allows you to meet the 20% down criteria by putting 10% cash down and getting the other 10% from a second mortgage. Doing so eliminates the need for mortgage insurance.

• Jumbo: If you buy a house with a price tag that exceeds your area’s loan limits, you may need a jumbo loan. Only some areas offer conforming jumbo loans; most are non-conforming.

Each type of loan has its own set of qualifying requirements.

What Are the Requirements for Conventional Loans?

To secure a conventional loan, lenders evaluate a set of criteria to gauge an applicant’s ability to pay and the risk for the lender in providing the loan. Requirements may vary between lenders, and how you do in one area can alter conditions in another. For most conventional loans, financial institutions require a credit score of 620 or higher and a debt-to-income ratio of 36%-43%.

Minimum down payment requirements range from 3% to 20% for conventional loans. Whenever a borrower has less than 20% for a down payment, the lender requires the buyer to get mortgage insurance, which costs between 0.5% and 1.5% of the loan amount annually. Borrowers must pay this insurance until they have 20% home equity.

Every year, the Federal Housing Finance Agency sets loan limits for loans backed by government-sponsored enterprises Fannie Mae and Freddie Mac. The FHFA establishes limits based on changes in average home prices in the U.S. In 2022, the agency set the limit for conforming loans at $647,200 for most of the country. High-cost areas have limits as high as $970,800.

What Are the Benefits and Drawbacks of Conventional Loans?

The primary benefit of conventional loans is that they can be less expensive in the long run than FHA loans. You can qualify for lower interest rates if you have a high enough credit score. Keep in mind that if you make a down payment of less than 20%, you have to procure mortgage insurance with your loan. However, you save the upfront mortgage insurance premium the FHA requires.

The drawback to these loans is that your credit history, debt-to-income ratio and down payment usually carry more weight. Lenders tend to offer better interest rates to those with a more robust financial standing. You may qualify for a conventional loan, only to discover that the interest rate offered is substantially higher than expected.

Get the Facts About FHA Loans

The Federal Housing Administration began its mortgage insurance program in 1934 to alleviate the challenges lenders and homebuyers faced during the Great Depression. The FHA doesn’t provide loans but backs them with insurance for the lenders. If a borrower defaults on the mortgage, the FHA covers the balance of the loan.

With the government’s backing, lenders can extend loans to those with lower credit scores, income and down payments. However, borrowers pay a monthly mortgage income premium and an upfront 1.75% MIP. FHA mortgages offer loans with down payments as low as 3.5%.

What Are the Requirements for FHA Loans?

FHA loans have more flexible requirements than conventional loans. To qualify for better interest rates and a 3.5% down payment, you need a minimum credit score of 580. However, if your credit score is between 500 and 579, you may qualify for a 10% down payment loan. The debt-to-income ratio is 43%, and you must show proof of employment and steady income.

All FHA-backed loans require mortgage insurance, with a 1.75% initial premium to be paid upfront and a 0.85% premium every month for the life of a 30-year fixed-rate loan. You can only get an FHA loan for a primary residence. The loan limit for FHA loans is lower than conventional ones, with a $420.680 cap for most areas in 2022.

What Are the Benefits and Drawbacks of FHA Loans?

FHA loans provide more people an opportunity to buy a home, with more flexibility in credit scores, debt-to-income ratios and down payments. An FHA loan may offer better interest rates for those whose credit is on the lower end of the qualifying range for conventional loans. Lower interest rates can reduce the overall costs, even with the MIP.

The primary drawback to these loans is that those who qualify for lower interest rates on conventional loans will pay more in the long run for an FHA loan with the same interest rates. Every borrower pays the 1.75% upfront premium. Additionally, insurance premiums generally continue for the life of the loan. Those who can put 10% down pay a MIP for the first 11 years of the loan.

Choose the Right Loan for You

There is no one-size-fits-all advice for the best mortgage option. The right choice depends on your circumstances and home-buying goals.

When Is a Conventional Mortgage a Good Option?

A conventional loan may be a good option if your credit score is high enough to qualify for competitive interest rates. Often, this means scores higher than the 620 minimum. Conventional may also be the way to go if you have a low debt-to-income ratio and can afford a substantial down payment.

All these factors contribute to getting a lower interest rate. If you can pay a 20% down payment, you also eliminate the need for mortgage insurance.

When Is an FHA Mortgage a Good Option?

If your credit score is between 500 and 619, an FHA loan may be your best option. People with scores in that range have difficulty qualifying for a conforming conventional loan, and non-conforming loans usually have much higher interest rates and pose risks for the borrower.

FHA loans are often the better choice if your debt-to-income ratio is above 36% and you don’t have the funds for a higher down payment. If you qualify for a conventional loan but can’t secure a competitive interest rate, you may want to investigate an FHA loan.

What Is the Right Choice for First-Time Homebuyers?

Though most people associate FHA loans with first-time homebuyers, they aren’t only for those looking to buy their first home. Furthermore, if you are a first-time home buyer, you have the following additional options:

• HomeReady: These loans are offered through Fannie Mae to help those with qualifying credit but low income and limited down payment capabilities get into a house. HomeReady loans let borrowers use supplemental income from a renter or border to help them qualify for a loan.

• HomeOne: Freddie Mac offers 3%-down mortgages to first-time homebuyers with qualifying credit scores who require financing flexibility.

• Home Possible: Another Freddie Mac product, Home Possible provides first-time (and low-income) buyers a 3%-down mortgage option with the flexibility to secure their down payment from various sources. Income is limited to 80% of the median in the homebuyer's area.

These mortgages fall under the conforming conventional loan category, but they give first-time homebuyers an extra boost in securing low down payments and lower interest rates. However, they still require a minimum credit score of 620.

FHA vs. Conventional Home Loan FAQs

Here are some answers to the most frequently asked questions about FHA vs. conventional loans.

What Is an FHA Loan?

The Federal Housing Administration backs the mortgage of an FHA loan. People with lower credit scores down to 500 can secure a loan with a 3.5% or 10% down payment. In turn, they must pay a monthly mortgage insurance premium. If borrowers default on their loans, the FHA pays the remaining balance.

How Is a Conventional Loan Different From an FHA Loan?

A conventional loan does not have government backing through a federal mortgage insurance policy. Conventional loans have a higher minimum credit score and generally lower debt-to-income requirements. However, those who can’t pay a 20% down payment still need to procure mortgage insurance from a private insurer.

Is a Conventional Loan Better Than an FHA Loan?

A conventional loan isn’t always better than an FHA loan. Those with strong credit scores, low debt-to-income ratios and the money for higher down payments may find conventional loans to be the better option. However, even people who qualify for conventional loans may get a better interest rate with an FHA loan if their financial criteria aren’t enough to secure competitive interest rates.

Are FHA Loans Only for First-Time Homebuyers?

No, FHA loans are not just for first-time homebuyers, though many think they are. First-time homebuyers often benefit from these loans because they haven’t had time to establish a strong credit history or save up a sizeable down payment. However, anyone who meets the requirements can apply for and obtain an FHA loan.

Is a Conventional Loan Less Expensive Than an FHA Loan?

A conventional loan is less expensive than an FHA loan if the borrower has a high enough credit score and down payment to secure a competitive interest rate. An FHA loan may be the less expensive option for those who don’t qualify for competitive interest rates, even with the added 1.75% upfront mortgage insurance premium requirement.

Make an Informed Decision Between Conventional vs. FHA Loans

Whether a conventional or FHA loan is the right choice for you often depends on nuanced individual factors. When you have enough information to understand the differences and the pros and cons of each mortgage type, you can make an informed decision. You may also want to discuss your options with a loan officer who can help you compare loans based on your circumstances.