If you’re a first-time home buyer then one of big decisions (and the first) you will need to make is what kind of mortgage you want. Before choosing things like fixed-rates or ARMs, you need to decide if you will get an FHA or conventional loan. What’s the difference? Well let’s break it down for you.
What is an FHA Loan?
An FHA loan is a mortgage loan that is backed or insured by the FHA (Federal Housing Administration) which is a government agency. The way it works is the federal government insures loans for approved lenders to reduce the risk of loss if a homeowner/ borrower defaults on their mortgage. FHA loans are easier to get than other loans because they are available for buyers with less than perfect credit and there are low down payment options.
What is a Conventional Loan?
A conventional loan is everything else. A conventional loan is not insured by the federal government and also known as a conforming mortgage. These mortgages adhere to the guidelines set by Fannie Mae and Freddie Mac and can have either a fixed or adjustable rate. Conventional home loans typically require a larger down payment however they differ from lender to lender. Recently there have been regulation changes geared at helping first-time buyers more easily obtain mortgages as well which is good news for buyers interested in conventional loans.
Renee Wiginton, experienced financial advisor with First Team, helped put together this helpful chart for home buyers and their agents to better understand the differences in price between FHA and conventional loans. Renee works with real estate agents and their buyers to help them find the perfect loan to fit their financial situation. This chart is based on a price break down common among first-time buyers – a home purchase on a property listed at $400,000 with a 5 percent down payment.
If you’re a first time buyer in Southern California (and Orange County especially) you’re also probably looking at condos for sale because they’re more affordable than single family homes and require a smaller initial down payment.
FHA or Conventional Loan: Price Comparison
|Sales Price: $400,000||Sales Price: $400,000|
|Base Loan Amount: $386,000||Base Loan Amount: $380,000|
|Total Amount (Including Financed Mortgage Insurance Premium): $392,755||Total Amount: $380,000|
|Principal & Interest (4%): $1,875.07||Principal & Interest (4.25%): $1,869.37|
|Monthly Mortgage Insurance: $441.84||Private Mortgage Insurance: $218.50|
|Taxes: $400||Taxes: $400|
|Insurance: $50||Insurance: $50|
|Total Monthly Mortgage Payment: $2,766.91||Total Monthly Mortgage Payment: $2,537.50|
|Down & Closing: $23,000||Down & Closing: $29,000|
The biggest differences in price that jump out are the extra charges that go along with FHA loans. FHA loans include a mortgage insurance premium and higher monthly mortgage insurance (almost twice the amount of a conventional loan’s private mortgage insurance!). Because FHA has looser underwriting standards, they charge a higher insurance to protect themselves against the possibility of homeowners defaulting on mortgage payments.
With a conventional loan you will need to have more money for the down payment and closing costs for a conventional loan, however you will save substantially in the long run from the reduced monthly payments if you can afford it now.
6 Benefits of Conventional Loans
Renee encourages her clients to look at all of the facts, immediate and long term, in order to make the right financial decision when it comes to choosing an FHA or conventional loan. For some, an FHA loan is the only way to get into a home. However, if you have the option of going conventional it can be extremely beneficial in the long run. According to Renee, here are 6 benefits of choosing a conventional loan that you might not know about:
1. Buyers can request $6,000 credit for closing costs from seller. Although the down payment and closings costs for the conventional loan are $6,000 more, buyers can request that same amount in closing credits from the seller. It is common practice for sellers to pay closing costs so it’s worth negotiating into your home purchase.
2. Saving $229 per month by choosing conventional financing gives you $45,000 in buying power. That means that if you wanted to buy a slightly nicer condo with an extra bedroom for $445,000 instead of the FHA approved $400,000 residence, you would still be paying the same monthly mortgage payments by going conventional.
3. FHA loans require property approval. Renee says, “Condominium project must be approved by the HUD and it’s a pretty short list these days. The great affordable condo you found while house hunting may not be eligible to purchase with an FHA loan.” Finding a property which is FHA approved greatly limits your pool of potential homes. You can check for FHA approved condos here on the HUD site.
4. Convention loans now accept 100% gift funds. In the past if you had a gift then you had to go FHA, you didn’t have the option to go conventional because buyers had to have at least 5% of their own funds in order to qualify. However as of October of 2013 Fannie Mae removed that restriction which opens up more options for first-time home buyers.
5. FHA Monthly Mortgage Insurance (MMI) can never be removed however Private Mortgage Insurance (PMI) on conventional loans can be. PMI can be removed after 24 months of payments and 20% equity has been achieved by the borrowers. MMI can only be removed on an FHA if the homeowners refinance. If you can get your mortgage insurance removed then that’s thousands of dollars you will be saving each year on your mortgage payments.
6. With conventional loans non-borrowing spouse debts are not considered. Say you’re married and are ready to purchase a house. Your credit is stellar but your spouse’s, not so much. Even if the loan is in your name alone, your non-borrowing spouse’s debts will still be considered to qualify for FHA. That’s right; even if the loan is not in their name the lender will still pull your spouse’s credit and include it in the consideration for your loan. Conventional loans on the other hand do not count non-borrowing spouses debts.
The final decision is up to you. But when you’re researching home loans, don’t forget to consider the pros and cons of each. Whether you get an FHA or conventional loan, the most important thing to do is make a plan and stick to it!