When buyers start the process of getting pre-qualified, they often hear their loan officer throw out statements like these …“In your case a Conventional loan would be best because you have a large down payment” OR… “In your case a FHA loan is going to best for you because your credit scores are in the mid 600’s”. Many buyers want to understand the difference between a Conventional and a FHA loan. What is the advantage of one program over the other?
The debate whether a borrower is better off with a Conventional VS FHA loan changed drastically on 4/1/2013. FHA announced that they were increasing their mortgage insurance premiums (MIP). AND just a couple of months later, on 6/3/2013 FHA announced a policy that would keep FHA mortgage insurance permanently on a most FHA loans. You can go to our FHA page to learn about FHA mortgage insurance cancellation rules. Borrowers, at that point, began looking at conventional loans for an alternative.
Call
+1 602-535-2171
for a Free Consultation
Borrowers have always been attracted to the FHA loans due to the low down payment requirement of 3.5%. For the buyer who is short on down payment funds, but can afford the monthly MIP, this loan fits. Conventional loans with comparatively lower interest rates will require a 5% down payment. That’s only another 1.5% down vs. the FHA competitor, and just might end up saving borrowers quite a bit of money in the long run.
Let’s take a look at some of the criteria for each of these loans and who they are better suited for.
FHA loans are typically better suited for:
Borrowers who are in need of a smaller loan amount. See my FHA loan page to find what current FHA loan limits are.
Borrowers with credit scores less than 700
Borrowers who have less than 5% down payment and no reserves
Borrowers who need a gift for the down payment and/or the closing costs and prepaid taxes and insurance
Borrowers who have a past foreclosure between 3 and 7 years old – (conventional loans will not allow it)
Borrowers who have a past short sale between 2 and 4 years old – (conventional loans will not allow it)
Conventional loans are suited for:
Borrowers who are in need of a larger loan amount. See my conventional loan page to find conventional loan limits.
Borrowers who have saved a minimum of 5% down payment PLUS closing costs and prepaid taxes and insurance.
Borrowers with higher credit scores, the higher the credit score the lower the interest rate and costs the borrower will have.
Borrowers who have never had a foreclosure OR if they have, it must be at least 7 years or older.
Borrowers who’ve never had a short sale; if they have, it generally requires that it be at least 4 years or older.
Comparison 1: Borrower has credit score >760 and puts 5% down on each to compare apples to apples
| Conventional 30 Year Fixed | Fixed 30 Year FHA | |
|---|---|---|
| Sales Price | $ 300,000 | $ 300,000 |
| Down Payment | 5% | 5% |
| Interest Rate | 3.875% | 3.250% |
| Financed Upfront MI | $ 0.00 | $ 4,987 |
| Loan Amount | $ 285,000 | $ 289,987 |
| Principal & Interest Payment | $ 1,340 | $ 1,262 |
| Taxes | $ 150 | $ 150 |
| Homeowners Insurance | $ 60 | $ 60 |
| Mortgage Insurance | $ 85 | $ 201 |
| HOA Payment | $ 0.00 | $ 0.00 |
| Total Monthly Payment | $ 1,635 | $ 1,637 |
| Down Payment in $ | $ 15,000 | $ 15,000 |
| Total Closing Costs - ALL FEES | $ 2,600 | $ 2,600 |
| Total Cost of Points | $ 0.00 | $ 0.00 |
| Prepaid Taxes, Ins., & Interest | $ 1,500 | $ 1,500 |
| Estimated Cash to Close | $ 19,100 | $ 19,100 |
Notes:
The Conventional loan is the clear winner in this case
FHA MI is more expensive and on for life of the loan!
FHA loan payment is $38/month more
Conventional mortgage insurance is potentially eligible to removed after 2 years under certain circumstances.
Comparison 2: Borrower has a credit score of 660 and puts 5% down on each to compare apples to apples
| Conventional 30 Year Fixed | Fixed 30 Year FHA | |
|---|---|---|
| Sales Price | $ 300,000 | $ 300,000 |
| Down Payment | 5% | 5% |
| Interest Rate | 4.990% | 3.250% |
| Financed Upfront MI | $ 0.00 | $ 4,987 |
| Loan Amount | $ 285,000 | $ 289,987 |
| Principal & Interest Payment | $ 1,528 | $ 1,262 |
| Taxes | $ 150 | $ 150 |
| Homeowners Insurance | $ 60 | $ 60 |
| Mortgage Insurance | $ 308 | $ 201 |
| HOA Payment | $ 0.00 | $ 0.00 |
| Total Monthly Payment | $ 2,046 | $ 1,637 |
| Down Payment in $ | $ 12,500 | $ 12,500 |
| Total Closing Costs - ALL FEES | $ 2,600 | $ 2,600 |
| Total Cost of Points | $ 0.00 | $ 0.00 |
| Prepaid Taxes, Ins., & Interest | $ 1,500 | $ 1,500 |
| Estimated Cash to Close | $ 19,100 | $ 19,100 |
Notes:
The FHA loan is the clear winner in this case.
The FHA loan payment is $373/month lower
Even though the FHA loan has upfront mortgage insurance of $4,987 it would essentially be a break-even in 14 months ($4,987 divided by the monthly savings of $373). So, that is a very quick break even.
This second analysis of the Conventional vs FHA loan shows that the Conventional mortgage rate is quite a bit higher, due to the low FICO score.
The conventional mortgage has increased well beyond the FHA mortgage insurance amount.