You're buying or refinancing a home, and wonder whether an FHA loan or conventional loan is your best choice. We'll compare features and benefits of each. In general, loans backed by the Federal Housing Administration offer more flexible loan approval requirements and lower down payments. These features can make an FHA mortgage a great choice for first-time and moderate-income home buyers.
FHA Loans: Low Down Payments, High Mortgage Insurance Costs
FHA loans are a good choice for home buyers who don't have the larger down payments required of conventional mortgages. You can make a minimum down payment of 3.50 percent, while conventional loans typically require 10 to 20 percent down. The Federal Housing Administration is a federal government agency that insures mortgage lenders against losses on loans it guarantees. This provides lenders the ability to make FHA loans with low down payments, but there is a trade off. FHA borrowers are required to pay an upfront mortgage insurance premium that is typically rolled into your mortgage amount and an annual mortgage insurance premium. The annual premium is prorated monthly and added to your mortgage payments along with funds collected for paying property taxes and hazard insurance premiums. The upfront mortgage insurance premium is usually 1.75 percent of your mortgage amount, but can be as low as 0.01 percent for streamline refinancing of FHA loans endorsed on or before May 31, 2009.
The annual mortgage insurance premium for FHA loans is .55 percent of your mortgage amount. For example, if your mortgage amount is $200,000, the annual MIP amount is $1100. If your down payment is 10 percent or more, FHA's policy allows for cancellation of the annual premium after 11 years. If your down payment is less than 10 percent, FHA mortgage insurance remains in effect for the life of the loan.
FHA also allows mortgage lenders to approve borrowers with minimum credit scores of 500, but borrower credit scores of 500 to 579 require a 10 percent minimum down payment. Mortgage lenders are permitted to add their own credit requirements to FHA minimum requirements for loan approval. This means that lenders may require credit scores higher than FHA's minimum acceptable credit scores.
FHA loans are a great choice for those rebuilding their credit or who don't have a down payment of five to twenty percent.
Conventional Loan: Eliminate Mortgage Insurance Cost with 20 Percent Down Payment
Home buyers with sufficient resources and credit standing will likely find a conventional loan appealing. Conventional mortgages are not backed by government agencies, but a down payment of less than 20 percent for a conventional loan will require private mortgage insurance. Conventional mortgage lenders typically set the bar higher for credit scores and expect a minimum credit score of 680 or above to qualify.
Mortgage lenders typically allow you to cancel private mortgage insurance after your home's loan to value ratio reaches 80 percent or less. Estimate your loan to value ratio by dividing your mortgage balance by your home's current value. If your mortgage balance is $160,000 and your home is worth $220,000, your home's loan to value ratio is approximately 73 percent. According to Fannie Mae, conventional mortgage insurance may be automatically terminated by the lender when the loan to value reaches 78 percent or after a fully amortized payment schedule has reached its mid-point. Your mortgage payments must be current in order for conventional mortgage insurance to be terminated.
In general, if you can make a 20 percent down payment and have credit scores of 720 or higher, your best choice would be a conventional loan.
When you're ready to shop mortgage loans, our network of mortgage lenders can help. Please request mortgage quotes for FHA and conventional loans from our lenders. You can compare costs for each loan type side-by-side to help with finding the FHA loan or conventional loan that best works for you.