FHA vs Conventional loans, yes another post!

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For those of you who followed my posts in a previous life (in other words, my previous blog), you know I spent numerous posts detailing differences between conventional and FHA loans. For example, you can read here, here, here, here, here and here to get you started.

Like the typical never-ending-sequel-horror-movie that comes out every October, here we are again to address the differences between these two!

seriously, we need a 7th Saw film?!?

With the recent changes to FHA mortgage insurance going into effect on October 4, 2010, I know the questions on whether or not to use an FHA versus a conventional loan will pick up again. Consumers will want to know how the new guidelines impact the total monthly payments on conventional and/or FHA loans.

Whether or not to get an FHA or conventional loan should be up to a borrower’s unique situation. In order to accomplish this, borrowers should always speak to a mortgage consultant who take the time to ask probing questions about their situation and goals instead of quoting rates for the same loan program to everyone that comes their way.

That being said, let me try to shed some light on the latest change by using the example of a borrower looking to buy a home for $200,000 with a credit score of 720+ using a 30 year fixed loan.

We will look at principal and interest payments and mortgage insurance payments only. Property taxes and home owners insurance will be ignored as they will be the same regardless of the loan program used under this scenario:

  • FHA: a 3.5% minimum down payment is required and the 1% up front mortgage insurance fee is rolled into the loan. This gives us a total loan amount of $194,930. At a rate of 4.500%, the monthly principal and interest payment is $988 and the monthly mortgage insurance payment is $146. That totals up to $1,134 per month.
  • Conventional: a 5% minimum down payment is required and there is no up front mortgage insurance fee. The loan amount is $190,000. At a rate of 4.500%, the monthly principal and interest payment is $963. This payment is lower than FHA option because the loan amount is almost $5,000 less for the conventional loan. The monthly mortgage insurance is $149 (higher than FHA per month), and the total is $1,112.
  • Under this scenario, an FHA loan is $1134 per month versus $1,112 per month for the conventional loan. A difference of $22, or 2% higher for the FHA loan.

I guess that settles it… it is always better to use a conventional loan… right? Well, maybe or maybe not. This scenario assumes the borrower has at least a 5% down payment and a credit score of 720+. It also assumes the borrower has the credit trade lines necessary to qualify for an FHA loan. That leads us to some great questions:

  • What options are there for a borrower with only 3.5% to put down?
  • What if one borrower has four lines of credit on their credit report, but the co-borrower only has one?
  • What if a family member wishes to gift the entire down payment?
  • What if the borrower needs a non-occupant-co-borrower to qualify?
  • What happens if one’s credit score falls below 720? What about 680?

Those are excellent questions and further proof as to why one should always speak to a mortgage consultant who asks lots of questions and gets all the details pertaining to each individual’s situation. We can talk about pros/cons for FHA and conventional loans, but answers to all of these questions (and more) need to be known before one truly knows which is the better loan program for them to use – FHA or conventional.

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2 Responses to “FHA vs Conventional loans, yes another post!”

  1. Joe from San Diego Says:

    Great comparison. I think once the private mortgage insurance people relax a bit it will be game over. FHA will only be covering a small niche of 640 to 680 fico borrowers.

    • Clay Says:

      Good point Joe and thanks for the comment. If/When conventional PMI does go down, conventional loans become more appealing and would seemingly make FHA more of a 640-680 niche. That said, don’t forget about the smaller down payment, all funds given as gift to borrower, and higher DTI thresholds. With all of those factors in mind, it appears FHA will be strong/around for a while. Thanks for reading!

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