FotoFlexer_Photo While hosting a homebuyer seminar recently, a recurring question was asked.  “What’s better, FHA Loans or Conventional Loans?”

As is often the case, the answer to that question is… it depends.  

Without getting into specific rate quoting which would obligate me to quote APR’s and other disclaimers, the average FHA 30-year rates have been hovering around 3.5% (unbelievable by the way).  The average Conventional 30-year fixed rates have been hovering at just under 4%.  Let’s call it a solid .25 – .5 point spread minimally. If you’re comparing nothing more than just rate versus rate, it’s a no-brainer.   You don’t need a calculator or an understanding of mortgage amortization to know that lower rate equals lower payment.

Most people however are surprised to find out, all things being equal, the difference is somewhat minute.  

For example, on a $150k loan amount, the principle and interest payment difference is approximately $32 per month.   Not to say that $32 doesn’t add up over the course of 30 years ($11,520 to be precise), but most folks won’t end up in the same house or at least the same loan for even close to that long.

But there’s more to it than just rate when comparing FHA to Conventional loans.  

Depending on the state and county, FHA has loan size limitations.   In the Atlanta metropolitan areas, the current cap on FHA loans in $342,700 (as of June 2015).  Follow the link for more information on FHA loan limits for your area.  

There are a number of other factors to consider when deciding which loan makes more sense such as down payment, credit scores and the term of the loan.

A perfect example of comparing these two loans came up just this past week when I met with a couple in the process of buying their first home.  They wanted to put 10% down on a home priced at $200k.  With a Conventional Loan, that meant they’d be financing $180,000 at 4%.  Because they’re financing more than 80% of the purchase price, that also meant a PMI payment of $81 per month.  

The same FHA loan however meant they’d be financing $181,800 due to FHA’s UFMIP (Up Front Mortgage Insurance Premium), which amounts to 1.75% of the loan amount. In addition to the higher loan amount, the monthly mortgage insurance payment required for an FHA loan was $120.   That’s about 50% higher than the amount of PMI required for the Conventional Loan.

 

Here’s how the two loans compared:

CONVENTIONAL LOAN

Purchase Price:  $200,000

Down Payment:  $10,000 (5%)

Loan Amount:  $180,000

Interest Rate:  4%

Principle & Interest:  $859.35

Mortgage Insurance:  $81

Total Payment Excluding Taxes & Insurance:  $940.35

 

FHA LOAN

Purchase Price:  $200,000

Down Payment:  $10,000 (5%)

Loan Amount:  $181,800

Interest Rate:  3.625%

Principle & Interest:  $820.89

Mortgage Insurance: $120

Total Payment Excluding Taxes & Insurance:  $940.89

 

Even though the interest rate is .375% lower, the payment for the FHA Loan is pretty much identical when compared to the the Conventional Loan. Besides the payment differential, there’s another important factor to note.  The monthly mortgage insurance for your standard Conventional Loan typically may (I can’t emphasize the word may enough here because there are a number of variables) drop off in two years or so.  

The mortgage insurance for the average 30-year FHA Loan won’t fall off until after ten years.

So what’s better, an FHA Loan or a Conventional Loan?  It depends primarily on how much you want to put down, your credit scores and the term of the loan.  In the scenario shown above, it would absolutely be the Conventional Loan.  

 

4 thoughts on “FHA or Conventional?

  1. I’m buying a house soon so this is very helpful. Mortgages appear quite daunting but your post was straight to the point. I think based on our down payment, we may be better off going FHA. Thanks so much – good stuff!

  2. One thing I’ve noticed is there are plenty of misguided beliefs regarding FHA mortgages. One myth in particular is that FHA loans are for folks with poor credit. Although that used to have some validity, in today’s market that’s no longer the case. Thanks for your posting.

Leave a Reply

Your email address will not be published. Required fields are marked *

*
*
Website