FHA vs Conventional Loans Explained | Real Estate License Guides

FHA loans require 3.5% down with a 580 credit score, while conventional loans need 3-20% down with a 620+ score. The biggest practical difference is mortgage insurance: FHA charges it for the life of the loan, while conventional PMI drops off at 80% equity. For mortgage loan originators, understanding when to recommend each product is a core competency.

What Are the Core Differences?

Here’s a direct comparison based on current guidelines from HUD and Fannie Mae/Freddie Mac:

Feature	FHA Loan	Conventional Loan
Minimum down payment	3.5% (580+ score)	3% (first-time buyers), 5-20% typical
Credit score minimum	580 (3.5% down), 500 (10% down)	620 (most lenders require 640+)
Mortgage insurance	MIP for life of loan (most cases)	PMI until 80% LTV, then removable
Upfront insurance	1.75% of loan amount	None
Annual insurance	0.55% of loan amount	0.22-1.5% (varies by credit/LTV)
Loan limits (2026)	$498,257 (standard), higher in HCOL areas	$766,550 (conforming), higher in HCOL
Property standards	Strict HUD appraisal	Standard appraisal
DTI ratio max	43% (up to 57% with compensating factors)	45% (up to 50% with strong reserves)
Occupancy	Primary residence only	Primary, second home, or investment

Loan limits update annually. Check HUD and FHFA announcements for current figures in your market.

How Does Mortgage Insurance Work for Each?

This is where the real cost difference shows up over time, and it’s the detail that matters most to borrowers.

FHA Mortgage Insurance Premium (MIP):

Upfront MIP: 1.75% of the loan amount, rolled into the loan balance at closing
Annual MIP: 0.55% for most borrowers (paid monthly)
Duration: Stays for the life of the loan if down payment is less than 10%. With 10%+ down, MIP drops after 11 years
Only removal option: Refinance into a conventional loan once you reach 20% equity

On a $300,000 FHA loan, that’s $5,250 upfront plus roughly $137/month in ongoing MIP. Over 10 years, you’d pay about $21,690 in mortgage insurance alone.

Conventional Private Mortgage Insurance (PMI):

No upfront premium (unless you choose lender-paid PMI at a higher rate)
Monthly PMI: 0.22-1.5% annually, depending on credit score and LTV
Cancellation: Automatically drops at 78% LTV, or you can request removal at 80% LTV
Typical timeline: PMI goes away in 5-9 years with normal payments and appreciation

On the same $300,000 conventional loan with a 700 credit score and 5% down, PMI might run $95/month and disappear after 6-7 years. Total cost: roughly $7,600 versus FHA’s ongoing payments.

For borrowers with scores above 700, conventional loans almost always cost less over the life of the loan thanks to PMI removal. For borrowers in the 580-640 range, FHA may be the only option.

FHA loans aren’t inferior products --- they serve a specific borrower profile well. According to HUD data, FHA insured approximately 15% of all purchase mortgages in 2025, with the average borrower credit score around 670.

FHA makes sense when:

Credit score is 580-639 (conventional may not be available or pricing is punitive)
Borrower has limited savings but steady income (3.5% down vs. higher conventional down payment)
Recent credit events (FHA has shorter waiting periods after bankruptcy --- 2 years vs. 4 years for conventional)
High DTI ratio with compensating factors (FHA allows up to 57% with strong reserves)
Gift funds cover the entire down payment (FHA allows 100% gift funds)

FHA makes less sense when:

Score is 720+ (conventional pricing will be significantly better)
Borrower can put 10-20% down (no need for MIP)
Investment property or second home (FHA is primary residence only)
Loan amount exceeds FHA limits in the area
Borrower plans to keep the loan long-term (lifetime MIP adds up)

When Does Conventional Win?

Conventional loans offer more flexibility and lower long-term costs for well-qualified borrowers.

Conventional is better when:

Credit score is 680+ (much better PMI rates)
Down payment is 10%+ (PMI drops faster or isn’t needed at 20%)
Buying a second home or investment property (FHA doesn’t allow this)
Loan amount exceeds FHA limits
Property might not pass FHA appraisal (older homes, fixer-uppers)
Borrower wants to eliminate mortgage insurance eventually

Fannie Mae and Freddie Mac data shows that conventional borrowers with 740+ scores and 20% down get the best rates in the market --- typically 0.25-0.5% lower than equivalent FHA rates before accounting for MIP.

What About Property Requirements?

FHA appraisals are stricter than conventional ones, and this catches many first-time buyers off guard.

FHA appraisal requirements (HUD Handbook 4000.1):

Roof must have at least 2 years of remaining life
No peeling paint on homes built before 1978 (lead paint concern)
All mechanical systems must be functional
No structural deficiencies
Adequate heating for the climate
Safe water and sewage systems
Handrails on stairs with more than 3 risers

Common FHA appraisal failures:

Chipped exterior paint on older homes
Missing handrails
Broken windows
Non-functional appliances (if they convey)
Water damage or evidence of leaks

Conventional appraisals focus primarily on market value. The appraiser notes safety issues but doesn’t enforce the same repair requirements. For buyers purchasing older homes or properties needing cosmetic work, conventional loans create fewer closing delays.

How Do Closing Costs Compare?

Total closing costs are similar, but the structure differs:

Cost Component	FHA	Conventional
Upfront mortgage insurance	1.75% of loan	$0
Appraisal	$400-700	$400-700
Origination fee	0-1%	0-1%
Title and escrow	Varies by state	Varies by state
Total typical range	3-6% of loan	2-5% of loan

FHA’s upfront MIP is the main differentiator. Most borrowers roll it into the loan rather than paying cash at closing, which increases the loan balance by 1.75%. On a $300,000 loan, that adds $5,250 to the balance.

One advantage for FHA borrowers: sellers can contribute up to 6% of the purchase price toward closing costs, compared to 3% for conventional loans with less than 10% down. This can help cash-strapped buyers cover more expenses.

What Should MLOs Know About Overlays?

Published guidelines from FHA and Fannie Mae/Freddie Mac set the floor, not the ceiling. Individual lenders add “overlays” --- additional requirements beyond the minimums.

Common overlays to watch for:

Credit score: Many lenders require 620+ for FHA (above the 580 minimum) and 660+ for conventional
Manual underwriting: Some lenders don’t offer FHA manual underwriting, limiting options for borrowers with non-traditional credit
DTI limits: Lenders often cap DTI below the agency maximum
Reserves: Additional savings requirements beyond what agencies mandate

As an MLO, knowing your lender’s overlays is essential. A borrower rejected at one company might qualify easily at another. According to CSBS data, overlay differences between lenders account for a significant number of initial denials that become approvals elsewhere.

For a deeper look at becoming an MLO and understanding the products you’ll originate, our licensing guides cover the full path from SAFE Act education through your first funded loan.

Quick Decision Framework

For borrowers struggling to decide, here’s a simplified framework:

Borrower Profile	Best Option	Why
580-639 credit, minimal savings	FHA	May be the only qualifying option
640-679 credit, 3-5% down	Compare both	Run scenarios; FHA may have better rate
680-719 credit, 5-10% down	Likely conventional	Better PMI rates, removable insurance
720+ credit, 10%+ down	Conventional	Significantly cheaper long-term
Any credit, investment property	Conventional	FHA doesn’t allow non-primary residence
Recent bankruptcy (< 4 years)	FHA	Shorter waiting period (2 vs. 4 years)

The right answer depends on the individual borrower’s finances, timeline, and goals. Running both scenarios with actual rate quotes --- not just published rates --- gives borrowers the clearest comparison.

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