Smaller isn’t always better

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I know the phrase is actually “bigger isn’t always better,” but in the mortgage world, smaller is the way to go! Right?!? Smaller monthly payments… interest rates… etc. Smaller is always better! Maybe not when it comes to down payments on a home purchase.

A few months ago, Fannie Mae reintroduced their 3% down conventional loan. With only a 3% down payment required to qualify for the loan, that means there is a conventional loan program out there with a smaller down payment requirement than an FHA loan (203b needs 3.5% down). That means the conventional product is better, right?

For a comparison of the two, let’s look at a purchase price of $250,000:

  • 3% down conventional: $250,000 purchase price means the loan amount is $242,500. At a rate of 4.75%, the monthly P&I payment is $1,264.99. The monthly private mortgage insurance payment is $218.25 for a total of $1,483.24.
  • 3.5% down FHA: $250,000 purchase price means the loan amount is $241,250. Then tack on the FHA required 1% up front mortgage insurance premium to get a loan amount of $243,663. At a rate of 4.75%, the monthly P&I payment is $1,271.06. The monthly private mortgage insurance payment is $190.87 for a total of $1,461.93.

The larger down payment comes with a lower monthly payment ($21.31 less per month), but does that mean it is better? As usual, it all depends on the borrower. Let me explain:

  • To qualify for the 3% down conventional loan, the borrower must have a 700+ credit score. If the qualifying credit score is 650 or say 670, then the FHA route is the only option.
  • If the borrower only has 3% for the down payment and can’t wait to save the additional 0.5% amount needed for an FHA loan, just like the credit score dilemma, the 3% down conventional loan is the only option.
  • Another thing to consider is how long the borrower plans to remain in the home. If only 5-7 years or so, then I’d go FHA. Why? Because the borrower will always be paying mortgage insurance on the loan. Why not just go with the lower monthly payment. However, if this is the home for the long haul, I’d definitely go conventional because mortgage insurance can come off of a conventional loan faster than FHA (see this previous post for more details on this last statement).

What would I choose? How about a third option? After talking with a client, I would determine if they had enough assets to qualify for a conventional loan with a 5% down payment. On a $250,000 purchase with a 5% down payment, the loan amount would be $237,500. At a rate of 4.75%, the monthly payment would be $1238.91. Add on a monthly mortgage insurance payment of $186.04 and the total is $1,424.95. That is $37 less than the FHA loan, and $58 less per month than the 3% down conventional loan.

Why the difference? In addition to the lower loan amount, as the down payment amount increases on a conventional loan, the monthly mortgage insurance payment begins to decrease.

The key to determining which loan program is best comes down to finding a mortgage consultant who will take the time to ask questions, run the scenarios, and lay out the pros and cons of each choice. If you are in the market to buy a home anytime in 2011, I just might be able to help. Call or email me to get started on a purchase (or refinance) in the state of Georgia.

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