Selecting a conventional mortgage or a Federal Housing Authority (FHA) mortgage largely depends on two factors: Your credit score and how much you can afford to pay out of pocket for a down payment.

Funded by a lending institution and insured by the U.S. Department of Housing and Urban Development (HUD), FHA mortgages require, at minimum, a 3.5% down payment. Conventional mortgages, on the other hand, typically require at least a 5% down payment — although 20% is ideal because it generally removes the requirement for mortgage insurance, which can be costly.

Available to all qualifying homebuyers, not just first-timers, FHA mortgages offer more lenient income constraints but require buyers to live at the residence. An FHA mortgage may be a good option if your credit score hovers between 580 and 620. Applicants approved for a conventional mortgage usually maintain credit scores higher than 620. Conventional mortgages can be used for a primary residence, income properties or vacation homes.

Do I need mortgage insurance for a conventional mortgage or an FHA mortgage?

Mortgage insurance protects the lender in the event of foreclosure. Mortgage insurance companies look at your overall financial status when determining mortgage insurance rates. This includes your credit score, the amount of your down payment and your debt-to-income ratio. Mortgage insurance will likely cost less if you have a good credit score and show a low debt-to-income ratio.

In most cases, mortgage insurance rates are higher for FHA loans because borrowers often opt to pay less toward a down payment. Mortgage insurance increases your overall monthly payment, but it’s required for all FHA mortgages. Mortgage insurance is also required on a conventional mortgage if your down payment equals less than 20% of the total loan. FHA mortgages include a 1.75% upfront mortgage insurance premium paid by the borrower at closing.

It’s fairly easy to eliminate mortgage insurance on a conventional loan once you build up at least 20% in home equity. At that point, you can request the bank cancel mortgage insurance and reduce your monthly mortgage payments. If you paid a 10% down payment, you’re eligible to remove mortgage insurance from an FHA loan after 11 years.

Do conventional mortgages or FHA mortgages provide better interest rates?

A variety of factors determine mortgage interest rates, including your credit score, the amount of your down payment, the length of the loan and overall amount of the mortgage.

Conventional loans typically offer better interest rates but not always. In some cases, FHA mortgages come with lower interest rates than conventional mortgages because they’re backed by the federal government. However, you should factor in any upfront closing costs, loan fees and the price of monthly mortgage insurance to see which loan option offers the best deal for your particular financial situation.

Both FHA mortgages and conventional mortgages have maximum loan limits. According to the Federal Housing Finance Committee, the 2021 lending limit for one-unit properties is $548,250 on a conventional mortgage and $356,362 for an FHA mortgage.

	FHA Mortgage	Conventional Mortgage
Minimum Credit Score	580	Higher than 620
Down Payment	Minimum of 3.5%	Minimum of 5% — 20% is ideal
Mortgage Insurance	Required for all FHA loans. Can only cancel after 11 years if you made a 10% down payment. FHA loans also require buyers to pay a 1.75% upfront mortgage insurance premium at closing.	Required for down payments less than 20%. Can cancel once loan-to-value ratio reaches 80%.
Interest Rates	Typically higher interest rates than conventional mortgages. In select instances, they may be lower than conventional loan rates, but borrowers should also factor in upfront costs/fees and mortgage insurance premiums to decide on the best option for their situation.	Lower rates available with higher credit scores. Can get a fixed rate loan or an adjustable rate conventional mortgage, which starts with low rates but often rises during the life of the loan.

 

Need help deciding which mortgage loan is right for you? Speak with a First Merchants Bank lending expert today by calling 1.800.205.3464 or visiting a local branch.