Wiser Showdown – Conventional Loans vs. FHA Loans
One of the fun parts of being a mortgage loan originator is fielding phone calls from new borrowers who are shopping around to find the absolute best deal possible for their new home. They are many categories of “shoppers”, but my favorite is the first time homebuyer gathering as many quotes as possible and only focusing on the interest rate to make their decision. In this day and age of knowledge at everyone’s finger tips, I am amazed that I still talk to people who take advice from their 80 year old grandpa that the best interest rate is the best loan.
Unfortunately, there are still mortgage loan originators who understand this and in my opinion use this knowledge as a sales tactic to sell loans based on interest rate rather than what is the best fit for the client. One of the biggest examples of this is putting a new home buyer in an FHA loan because of the fancy shiny interest rate that comes with it and not fully discussing all the fine print that will end up costing them more money down the road.
As usual, my advice is to always work with a mortgage professional who is not just willing to show you multiple options but is insistent you fully understand what options you have and actually allow you to compare them all side by side. Here at Wiser Lending, our company Mission Statement is to educate each of our clients to empower them to make a sound financial decision. Which loan program definitely is included in that statement. Here is what you need to know to decide which loan program makes the most dollars and sense in your situation.
Wiser Showdown: Conventional vs. FHA
FHA Loans were first introduced in 1934 to fight against the high rate of foreclosures and defaults in the 1930s. The Federal Housing Administration wanted to provide mortgage lenders with adequate insurance to guaranty borrowers and help stimulate the housing market by making loans accessible and affordable for people with less than stellar credit or a low down payment. FHA does not actually loan the money, they simply guarantee to the lender that in the case of a default by the borrower they will back up the loan and help lessen any loss to the lender that may occur.
Sounds great to any first time homebuyer, a borrower that may have experienced some credit issues or anyone that has been unable to put together a sizeable down payment to purchase a new home. However, like everything else in life: There is no such thing as a free lunch! FHA loans are more expensive and you will be saddled with an additional mortgage insurance payment that may last the entire LIFE of the loan!
So if FHA loans are for new home buyers, borrowers with less than perfect credit and borrowers with smaller down payment, then why are some lenders pitching them to everyone else?
Short answer: They usually come with a lower rate than a conventional loan that appears more attractive to someone who has not read our Wiser Owl Blog or done enough research to find out that shiny FHA rate may end up costing more money.
My motto is go Conventional if you can and keep the FHA loans behind the glass that reads: “Break in Case of Emergency”. If you don’t have credit issues, enough income and work history, there is no reason to take an FHA loan. What about a large down payment? – We can get you qualified on a Conventional loan with as little as 3% down, especially if you are a first time homebuyer. FHA requires 3.5% down, so put another mark in the W column for conventional loans.
Let’s Compare and let the #s do the talking.
FHA 30 Year Fixed, 680 FICO score, 3.50% down, Purchase Price $250,000.
Base Loan Amount: $241,250 Final Loan Amount: $245,471 ( FHA charges an Upfront Mortgage Insurance Fee of 1.75% of the loan amount to use the program ($4,221.88 fee), this is financed into your loan)
Rate: 4.75% (based on today’s market and the scenario listed above, 5.049% APR)
Principle and Interest Payment: $1,280.49
FHA Monthly Mortgage Insurance Premium: $173.88 (This is a monthly charge that will remain on your loan for the entire LIFE of the loan, if you put down more than 10% then it remains for 11 years)
Total Payment: $1,454.37 ( This does not include Taxes and Insurance, for our example we will exclude them since they would be the same regardless of which program you choose)
Conventional 30 Year Fixed, 680 FICO score, 3% down, Purchase Price $250,000
Base Loan Amount: $242,500 ( there is no additional fee, so the base loan amount is the final loan amount)
Rate: 5.00% (based on today’s market and the scenario listed above, 5.144% APR)
Principle and Interest Payment: $1,301.79
Private Mortgage Insurance Premium: $151.56 per month ( This amount will be removed by law once you pay down the balance to below 80% of the value of the home)
Total Payment: $1453.35
So at the end of the day the Conventional loan saves you $1.02 per month in payment and you save $4,221.88 in additional upfront fees plus the PMI payment will eventually be removed from the conventional loan, while the $173.88 you pay to FHA every month will NEVER go away. Effectively, the FHA 4.75% with the additional $173.88 per month is actually like paying 5.89% on the loan since the additional FHA mortgage insurance never falls off. A wolf in sheep’s clothing!
Don’t be fooled when someone dangles a shiny new interest rate in front of you. Break down the math and compare the loans side by side: Total Monthly Payment, Total Costs and look at the long term as well to ensure you are really getting a good deal. Contact us Today and we’ll be more than happy to do the leg work for you and show you the best loan for your situation.
Wiser Showdown Winner: Conventional 3% down.
Eric Weishaar
President | NMLS# 207659