Both FHA and Conventional home loan programs offer great options with low down payments. However, there have been many recent changes that affect the overall benefits and costs of the FHA loan compared to a conventional loan.
Down Payment:
Most buyers today assume that an FHA loan is the best and only financing option available if they have a low down payment. Yes, FHA continues to offer the lower down payment option of 3.5% of the sales price versus the Conventional loan which requires a down payment of 5%. However, new Conventional guidelines will now allow the total 5% down payment to come from gift funds (provided by a relative), thus the borrower could contribute less or 0% of their own assets for the down payment.
Private Mortgage Insurance (PMI)/Mortgage Insurance Premium (MIP) Comparison:
PMI is insurance for Conventional loans and MIP is insurance for FHA loans. Both are required by the lender on most loan programs, which enables borrowers to purchase a home if they do not have a down payment of at least 20%. The borrower is required to pay the PMI/MIP premiums, which protects the lender for a portion of the loan in the event of default on the monthly mortgage payments.
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With the FHA fee increase effective June 2, 2013, both the borrower’s annual and monthly FHA mortgage insurance premiums have increased.
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FHA not only charges MIP on a monthly basis, they also charge an upfront mortgage insurance premium or guaranty fee of 1.75% of the loan amount. Assuming the down payment is the minimum 3.5%; the borrower will be required to pay MIP for the lifetime of the loan. This means that as long as you have your FHA loan, the MIP will never be removed from the payment. In order to eliminate the MIP you will have to pay off your loan or refinance into another product once you have 20% equity in your home.
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Conventional loans also charge PMI if the down payment is less than 20% of the sales price. However, the monthly charge for PMI will almost always be less than the FHA premium. Unlike FHA, the PMI will eventually be cancelled. Once your loan to value reaches 78% of the sales price, the servicer of your loan will automatically remove the monthly PMI charge. You can also request in writing that PMI be removed by providing a current appraisal that values the property at 80% loan to value.
Credit Scores: A borrower’s credit score will affect which loan products you can use as well as the interest rate and PMI rate.
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FHA loans currently require a minimum credit score of 620. The interest rate and MIP rate provided by FHA is not impacted by your credit score.
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Conventional loans require a minimum credit score of 640. For conventional loans, your credit score will impact the interest rate and/or PMI rate. The higher your credit scores the lower your rates.
As demonstrated in the following Loan Scenario, for most borrowers, Conventional financing with private mortgage insurance can offer significant monthly savings and will be the less expensive, smarter option, even with a higher interest rate. For qualified borrowers, it is the more affordable option, especially over the life of the loan.
Contact us today to learn more about mortgage financing and how it can affect buying your next home.
