What Is the Difference Between Conforming & FHA Mortgages?

When it’s time to buy a house, most people need a loan for the majority of the purchase, known as a mortgage. There are two major types of mortgages available to homebuyers: conventional and Federal Housing Administration loans, and a conventional loan comes in both conforming and nonconforming versions. Conforming loans differ from FHA loans in that they typically require a higher down payment and come with stricter credit restrictions than their FHA counterparts.

If you want to take out a loan to buy a home, you’ll learn about two types of mortgage loans: FHA and conventional. An FHA loan is issued by a government-sponsored enterprise, while a conventional loan is protected by private mortgage insurance. Due to the government backing, lenders tend to have more flexibility when issuing an FHA loan, including being able to accept someone with a slightly poorer credit rating and a higher debt-to-income ratio.

But when considering a GSE vs. FHA-alternative loan, like a conforming conventional mortgage, it’s not always safe to assume government-backed loans are the best option. With an FHA loan, you’ll likely pay insurance premiums for the life of the loan, whereas you can remove insurance payments once you only owe 80 percent with a conforming conventional loan. If your credit score is high, you may also find you can score a lower interest rate with a conforming conventional loan than you would with an FHA loan.

The biggest difference between a conforming mortgage and an FHA mortgage is its backing. An FHA loan is insured by the federal government, which gives lenders a bit more leeway in issuing loans to homebuyers. FHA loans are issued through the Federal Housing Administration, and the insurance covers the loan if you stop paying on it.

A conforming loan is a conventional loan that “conforms” to the limits set by Fannie Mae and Freddie Mac. As the government backing helps protect FHA loans, these limits help protect you against being issued a loan higher than what you can afford. However, there are also conventional loans called nonconforming home loans, also known as jumbo loans, which issue an amount above the limits to a borrower who meets a very strict set of qualifying criteria. The vast majority of conventional loans are conforming loans.

If you’re getting a conventional conforming or nonconforming home loan, you’ll need a fairly sizable down payment to get started. Although you may be able to find a lender who will issue a mortgage with a down payment as low as 3 percent, typical requirements are 5 to 20 percent. An FHA loan will only require 3.5 percent down. That means to buy a home for $300,000, you’ll need a down payment of $15,000 to $60,000 to qualify for a conventional home compared to going as low as $10,500 with an FHA loan.

Your down payment requirement will be based on your credit score. The lower end of a conventional mortgage will be reserved for those who have a score in at least the high 600s, as well as a large savings account as a cushion. With an FHA loan, you can enjoy the 3.5 percent down payment with a credit score as low as 580.

When a government-sponsored entity backs your loan, the lender is insured against default, but that comes at a cost to you. Although you can get in with a lower down payment on an FHA loan, you may find you end up better off with a conventional loan due to the FHA mortgage insurance you’ll pay. These rates are set based on the loan-to-value ratio and are required no matter how much your down payment is. If your payment was 10 percent or greater, FHA mortgage insurance can be removed after 11 years, but otherwise it remains for the life of the loan unless you refinance.

When comparing GSE vs. the FHA alternative, conventional loans, you’ll typically find PMI is a better deal. The cost of PMI can vary from one lender to the next, but you can get out of paying it altogether if you put 20 percent down at closing. Even if you’re paying it, once your loan reaches an 80 percent loan-to-value ratio, you can request that PMI be removed.

The biggest draw to an FHA loan is usually the easier qualification. Not only can you get in with a lower down payment, but you won’t face the strict standards you will with a conventional loan. If you’re trying for a nonconforming loan, where you’re asking for a conventional loan for a higher range of money than is typical, those qualification requirements are even fiercer.

The biggest determiner in the conforming loan vs. FHA decision is credit score. With a conventional loan, you’ll usually need a credit score of 620 or better, while you can get an FHA loan with a score as low as 580, or 500-579 if you put down a 10 percent down payment. You may be able to get in with a debt-to-income ratio as high as 50 percent with an FHA loan, while conventional loans will usually require it be 43 percent or less.

As you’re comparing a conforming loan vs FHA options, interest rates will also be a factor. Since it’s backed by the government, lenders have the leeway to be competitive with the interest rates they offer, but that doesn’t always mean you’ll get a better interest rate with an FHA loan. Those with a good credit score may find that lenders offer a better interest rate on a conventional loan for their specific circumstances.

One notable exception to this is a nonconforming loan, which will naturally come with a higher interest rate because you’re borrowing an amount above the government’s current limits. But even if you’re applying for a loan below those limits, it’s important to look at the interest rates you can get with a conventional and FHA loan, if you’d qualify for both. By weighing all factors, you’ll be sure you’re getting the best deal.

Some factors that may push you in direction of a conventional loan are the restrictions placed on FHA loans. That may not go for a nonconforming home loan, though, as the restrictions are higher due to the larger amount you’re borrowing. Although an FHA loan may be more accessible to those with questionable credit or a lower down payment, there are regulations attached.

The biggest difference between a loan from a GSE vs. FHA alternatives is that the money you’re borrowing must go toward an owner-occupied home. This means you can’t use it for a second home or rental property. But conventional loans aren’t assumable, so if you want to give your home to your child or your aging parents, you can’t simply let them take over the mortgage payments. You’ll need to officially sell the home to them and have them take out a loan of their own to pay for it.