FHA vs. conventional loan: which one is right for you?

What is the difference between FHA and conventional loans?

The big difference is who backs the loan. FHA loans are insured by the Federal Housing Administration, which is part of HUD (the U.S. Department of Housing and Urban Development). Conventional loans are not insured by the government. Most are sold to Fannie Mae or Freddie Mac and follow their rules.

Both can work for first-time buyers. Both offer low down payment options.

When I compare them for a client, I don't ask which one is "better." I ask which one costs less over the years you'll really keep the loan, and which one fits the house. That answer changes from person to person, so I always run both side by side.

How is mortgage insurance different on FHA and conventional loans?

Mortgage insurance is the biggest difference. It protects the lender if a loan isn't repaid, and you pay for it.

FHA loans have mortgage insurance no matter how much you put down. Conventional loans have it only when the loan is more than 80% of the home's value. The rules for how long it lasts are very different, too.

FHA mortgage insurance premium (MIP)

FHA loans have two parts. There's an upfront premium, which is usually added into the loan. Then there's an annual premium, paid monthly.

HUD lowered the annual premium for most loans endorsed on or after March 20, 2023 (Mortgagee Letter 2023-05). The rules for how long you pay it come from Mortgagee Letter 2013-04. For FHA case numbers assigned on or after June 3, 2013:

• If your original loan-to-value (LTV: your loan amount compared to the home's value) was 90% or less, annual MIP lasts 11 years or until the loan ends, whichever comes first.
• If your original LTV was above 90%, annual MIP lasts for the mortgage term (up to 30 years). On a typical 30-year loan, that means the life of the loan.

Paying down your balance or seeing your home value go up does not remove FHA MIP early. For most of my FHA clients, the real way out is refinancing into a different loan once the numbers make sense.

Conventional private mortgage insurance (PMI)

Fannie Mae requires mortgage insurance (or another approved credit enhancement) on conventional first mortgages above 80% LTV. A federal law, the Homeowners Protection Act, gives you a way to remove it. It applies to single-family primary home loans closed on or after July 29, 1999:

• By request at 80%. You can ask your servicer (the company you send payments to) to cancel PMI once your balance is scheduled to reach, or you pay it down to, 80% of the home's original value. You need a good payment history, no other liens (claims against the home) and no drop in value.
• Automatically at 78%. The servicer must end PMI when your balance is scheduled to hit 78% of original value, as long as you are current.
• At the midpoint. PMI must end the month after you reach the halfway point of your loan's payment schedule, even if you haven't reached 78%, as long as you are current.

Some investors, including Fannie Mae and Freddie Mac, may allow cancellation on better terms than the law requires, such as based on a new appraisal. Your servicer can tell you what applies to your loan.

Is FHA or conventional better if my credit score is lower?

Your credit score is often what tips the scale.

Conventional pricing depends a lot on credit score. Fannie Mae publishes a Loan-Level Price Adjustment (LLPA) matrix. It's a chart of pricing changes based on your credit score and LTV, with more changes for things like occupancy and loan purpose. Private mortgage insurers usually price their coverage by credit score and LTV, too. If you have strong credit and a solid down payment, you'll often get good conventional pricing and modest PMI.

FHA's annual MIP is set by HUD based on loan amount, LTV and term. It is not based on your credit score. Lender pricing on FHA can still vary with credit. But the mortgage insurance part doesn't climb the way conventional PMI can as scores drop. That's why FHA often comes out ahead for people with thin or bruised credit, even with the longer MIP.

Is an FHA appraisal stricter than a conventional appraisal?

Every loan needs an acceptable appraisal (a professional estimate of the home's value and condition). FHA and conventional just look at the house a little differently.

FHA appraisals check whether the home meets HUD's Minimum Property Requirements. HUD describes these as making sure FHA-insured homes are safe, sound and secure. If the appraiser finds items that fail those standards, they usually must be fixed before closing.

Fannie Mae lets conventional appraisals be done "as is" when issues are minor and don't affect safety, soundness or structural integrity. Think worn carpet or a cracked window pane. Problems serious enough to affect safety, soundness or structural integrity still have to be fixed.

If you're buying a home that needs some work, tell me early. It can affect which loan goes more smoothly and how we ask the seller for repairs.

How much can the seller pay toward closing costs?

Both FHA and conventional loans limit how much an "interested party," like the seller or builder, can pay toward your closing costs, prepaids (upfront items like taxes and insurance) and rate buydowns.

Fannie Mae's limits vary by occupancy and LTV. Anything over the limit is treated as a sales concession, which lowers the price used to figure your loan. Seller help also can't be more than your actual closing costs.

One helpful note: HUD has said that when sellers pay the buyer's real estate agent commission as a matter of local law or custom, and the amount is reasonable, FHA does not count it as an interested party contribution (FHA INFO 2024-12). I check the exact limit for your situation before you write the offer. That way the help you ask for is help the loan can actually use.

FHA vs. conventional: side-by-side comparison

When should I choose FHA vs. conventional?

FHA often makes sense when

• Your credit score would push conventional pricing and PMI noticeably higher.
• You have more debt or a recent credit problem and need the flexibility of a government-insured program.
• You expect your income or credit to improve and plan to refinance in a few years anyway.

Conventional often makes sense when

• You have strong credit, which tends to earn better pricing and lower PMI.
• You want mortgage insurance that can come off as you build equity.
• You're buying a second home or investment property, which FHA doesn't finance in the ordinary case.
• The home has small cosmetic issues that wouldn't block an "as is" conventional appraisal.

Can I refinance from FHA to conventional later?

Yes. Choosing FHA today doesn't lock you in forever. Many of my clients start with FHA, build equity and improve their credit. Then they refinance into a conventional loan to get rid of the monthly MIP.

Whether that makes sense depends on rates at the time, your equity, closing costs and qualifying again. It's never automatic. FHA also offers a streamline refinance for current FHA borrowers. That's a separate option worth a look if rates fall.

My honest advice: don't pick a loan type based on a rule of thumb. Ask your loan officer to show you both options side by side over five, seven and ten years. If you'd like me to run that comparison for you, reach out here. All loans are subject to credit approval, program guidelines and property eligibility.

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