FHA or Conventional?

While hosting a homebuyer seminar this weekend, 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 just under 3.75% (unbelievable by the way).   The average Conventional 30-year fixed rates have been hovering right at if not slightly above 4%.  Let’s call it a solid ¼ 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.

On a side note most people are surprised to find out, all things being equal, the difference is somewhat minute.   On a $150k loan amount, the principle and interest payment difference is just $21.45.   That’s not to say that $21.45 doesn’t add up over the course of 30 years ($7,722 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 $346,250.  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% of the loan amount.

In addition to the higher loan amount, the monthly mortgage insurance payment required for an FHA loan was $165.   That’s more than double 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 Excl Taxes & Ins:  $940.35

FHA Loan

Purchase Price:  $200,000
Down Payment:  $10,000 (5%)
Loan Amount:  $181,800
Interest Rate:  3.75%
Principle & Interest:  $841.94
Mortgage Insurance: $165
Total Payment Excl Taxes & Ins:  $1006.94

Even though the interest rate is .25% lower, the payment for the FHA Loan is $66.59 higher than 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 five years (there are some disclaimers to this but the general rule is five 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.

Print PDF