FHA loans have been the major talk in the news as of lately. One loan officer e-mailed me the other day, asking if FHA is going away. I asked, how did you come up with this? Because three realtors had mentioned it to them. I have not heard a thing, but let's use common sense. If FHA loans would go away, then the housing market would crash for good. Just my opinion.
Just the other day, a realtor made a comment stating that the buyer was better off putting their 20 percent down with a conventional mortgage and not with a FHA mortgage, so they could avoid the mortgage insurance. Okay, in theory, this sounds great, but there is a huge unknown that is not talked about. The borrower's credit score, which was a middle score of 623. Yes, you could still do a conventional loan down to a 620, if it gets approved in the system. But let's look at the numbers and understand this better.
The example below is based on a $275,000 purchase price with 20% down. One reason why conventional rates are a little higher and more costly in this scenario as in FHA rates is because Fannie Mae and Freddie Mac have added penalties per se. If you are putting down less than 30% and your credit score is less than 720, certain fee penalties would apply to you, which would increase your rate and or points. The credit score that I am going to use is 623 and I will still show in this example that FHA loans are cheaper (depending on your goals), even with 20% down while trying to avoid the mortgage insurance.
***And keep in mind, some lenders have penalties on FHA mortgages with credit scores under 660 or can't do them. And many lenders can't do FHA loans under 640 now. And beware of those that promise you a mortgage with scores under 620. It can happen, but they aren't as easy as advertised. Please read - Credit scores/FICO scores - I need a 700 credit score? ***
Disclaimer : These rates are examples of today's pricing, and the spread shown in the example is real with the same profit margin for both sides. The conventional rate also includes the penalty for the 623 credit score, hence why the interest rate is much higher.
One main fact is that you will be adding $2,200 onto your principal balance if you did the FHA mortgage because of the FHA one-time mortgage insurance premium. If you do the math, the conventional loan isn't better until after 2.7 years. But keep in mind, the FHA loan becomes better after year 5. Why is this? because the monthly mortgage insurance falls off after 5 years.
So, simple math. In the first 5 years, you would have spent approximately $2,360 more on the FHA loan scenario. But now you are saving $70 a month on the FHA loan and the principal balance is being reduced a tad quicker. So in theory, if you stayed in the house for 7 + years, the FHA loan would be better for you.
Another thought? You would need an extra $2,800 more for the conventional loan also, because of the steep penalty for the credit score.
Reminder : You will be subtracting a few more dollars per month from your principal because your interest rate is lower, which would offset the interest that you would write off on the 4.625% rate. Just something else to remember, but consult your tax consultant or CPA.
FHA Myth - Some people, including loan officers, without doing the math, will say that FHA loans are more expensive because of the Upfront Mortgage Insurance. Because in this scenario, you are adding $2,200 to the FHA loan and because of the new monthly mortgage insurance change. This kind of mortgage myth needs to be squashed on all levels. It starts with the borrowers goals.
This person is also thinking about wanting to do extra work within the property, and the 203-k loan is very useful for this situation.
Important Key Point - Don't fall for the trap when a loan officer would say, just refinance down the road. That could be a huge risk. Nothing is guaranteed for the future.
Disclaimer : All of the information is based on my knowledge and of opinion. I will always say that each and every borrower is not the same. And if you are buying in a USDA area or a Veteran, a USDA loan or a VA loan could be better.
For more FHA loans vs conventional loans comparisons :
- FHA loans vs Conventional loans - A true numbers comparison with 5% down - 12-20-08 -Using a 710 credit score
- FHA loans vs Conventional loans - A real comparison with 5% down - 11-15-08 - Using a 659 credit score
- FHA Loans vs Conventional Loans - 20% down - A Rude Reality Check - 04-03-09 - Would you believe that FHA loans could be cheaper even with 20% down? Come see why and how.
- FHA Loans vs Conventional Loans - 5% - 4 comparisons that you need to know - 05-02-09 -Comparing a FHA loan against 3 types of conventional loans with different types of monthly mortgage insurance. Guess who won while still using a 679 credit score.....
- FHA loans vs Conventional loans - Knowing the true comparisons - 07-10-09 - A great comparison with a 679 credit score and 5% down. This example will still show that even with a better than average credit score, that FHA loans are still better in many cases.
- FHA loans vs Conventional loans - Things you need to know with 10% down, especially in regards to Condos - 09-19-09 -
- FHA loans vs Conventional loans - Even with 20% down, FHA loans could be better - 05-23-10 - Knowing your goals are very important and this should be talked about, even if putting 20% down.
- FHA loans vs conventional loans - Why FHA home loans in New Jersey can be better with 5% down - 07-11-10 - There is a huge savings by using FHA loans with a credit score of 679 and 5% down.
- FHA Loans vs Conventional Loans - Proof that FHA home loans with 5% down after major change are still cheaper 09-01-10 - Even with the new FHA mortgage insurance changes, this tells you what loan is better and why.
- FHA Loans vs Conventional Loans - Comparing 20 percent down - Eye opening - 10-11-10 Understanding the differnce, even if you put 20% down. In this scenario, there is a reason why this person needs to put 20% down. I don't always agree putting more down if you don't have to. Please read my Cash is King series below.
Donw Payment Series - Cash is King - A Must Read -
- FHA loans vs Conventional loans - A real comparison with 20% down - Part 1 of 3 - 01-28-10 - Not much of a difference, unless you stay in the house for more than 5 years. Hence why a loan officer should be talking about your goals. So very important, yet many dont ask.
- FHA loans vs Conventional loans - Don't be cash poor!! - Part 2 of 3 - 01-29-10 I want to show even a bigger difference if you put less down. And even if you decided to put less than 10% down, because cash is king now. You can't predict even next week. And keeping in mind of some misleading rumors, that you need more than 10% down to buy a house.
- FHA loans vs Conventional loans - Get a bang for your buck - Large down payments aren't always the best way - Part 3 of 3 - 02-01-10 - Some great examples of having cash left over and not really affecting your monthly mortgage payment. And that you will have cash left over for emergencies. Keeping in mind that cash is king.