FHA or Conventional Mortgage Financing – What is the difference?

We get a lot of mortgage-related questions from our home buyers, and often those questions are best answered by a mortgage expert. Today’s post is a guest post from Rhonda Porter, a Mortgage Originator who has helped a number of findwell clients with their home loan needs. She also writes one of our favorite local mortgage blogs, The Mortgage Porter. Thanks for the informative post Rhonda!

rhondaporterWith the First Time Home Buyer Tax Credit, I’m seeing more buyers wanting to get preapproved to take advantage of the $8000 credit. The credit expires on November 30, 2009 which means in all reality that home buyers who qualify and who are wanting to take advantage of this benefit need to be in contract by early October. FHA is a popular program for first time home buyers and many have wondered what the difference is between FHA and conventional financing.

Here are some quick stats on FHA financing:

  • FHA mortgages allow people to purchase a home with as little as 3.5% down payment. Down payment may be a gift from family members.
  • Sellers can contribute up to 6% of the sales price towards actual closing costs and prepaid expenses once the buyer meets the 3.5% minimum down requirement.
  • FHA has both upfront and monthly mortgage insurance regardless of down payment. (FHA monthly mortgage insurance remains with the property for a minimum of 60 payments, unless the mortgage is paid off.)
  • Unlike conventional financing, FHA insured loans currently do not have “risk-based” pricing for credit scores over 620.
  • FHA loans are assumable. With today’s low rates, this could be attractive should mortgage rates be higher in the future.

Let’s compare a transaction based on a sales price of $400,000 with 5% down payment based on mortgage rates from September 14, 2009 at 12:00 pm. Let’s assume these are first time home buyers with mid-credit scores of 700.

FHA 30 Year Fixed

The base loan amount (95%) is $380,000. FHA has upfront mortgage insurance of 1.75% which is typically financed into the mortgage. The adjusted loan amount would be $6,650 (1.75%) + $380,000 = $386,650.

Current rate at 95% LTV (loan to value) is 5.000% (APR 6.008%). The payment would look something like this:

  • Principal and interest:  $2,075.62
  • Est. property taxes:  $416.75
  • Est. home owners insurance:  $50.00
  • Monthly mortgage insurance:  $158.33
  • TOTAL EST PAYMENT:  $2,700.62

5% down provides a slightly lower monthly mortgage insurance rate (0.50% vs. 0.55%) than 3.5% down payment. However, if a buyer wanted to, the could purchase a $400,000 home with $14,000 (3.5%) as long as the seller pays their closing costs and prepaid expenses. Remember, that down payment can be a gift from a family member as well.

Note:  The rate/payment above would apply whether your credit score is 620 or 800 when using FHA financing.

Conventional 30 Year Fixed

5.000% down payment and private mortgage insurance at 5.000% (APR 5.157).

  • Principal and interest: $2,039.92
  • Est. property taxes:  $416.75
  • Est. home owners insurance: $50.00
  • Monthly private mortgage insurance: $297.67

Private mortgage insurance with conventional financing can be quite enjoyable if you’re into being completely nit-picked. FHA guidelines tend to be more practical. Conventional financing also has price hits based on loan to values and credit scores. The credit score that you are judged by is the middle credit score. If you are financing your home with someone else, it’s the lowest middle score of all buyers that your rate and underwriting decisions are based on.

I admit, I’m probably biased towards FHA financing for most first time home buyers who are shy on savings. And, if someone has roughly 5% down payment, I think they should consider using just 3.5% down to save the remaining 1.5% down ($6,000 based on our example of $400,000) for their bank accounts. Owning a home does have expenses and most lenders will want to see home buyers with a minimum of two months reserves (two mortgage payments or roughly $5500 based on our example) in the bank AFTER closing regardless of what the underwriting guidelines state.

To learn which program is right for you, I recommend meeting with a local mortgage professional who is experienced with both programs. Even if you’re planning on using conventional financing, do ask your loan originator if they are approved to do FHA loans as well (and how long they’ve been originating FHA loans) and if their office has in-house FHA underwriting.

About Rhonda Porter

Rhonda Porter is a Mortgage Originator at Mortgage Master Service Corporation, a family-owned correspondent lender that has been helping Washington residents with residential mortgages for over 30 years.  Rhonda joined the Mortgage Master team in April of 2000 and appreciates the advantages of being able to select from many lenders and banks to work with while the processing, underwriting and funding all take place at her office.  She feels this is the best of both worlds for the consumer.  Mortgage Master is a direct endorsed HUD approved lender and offers FHA, VA, Conventional and USDA programs.  Prior to assisting people with their mortgages, Rhonda was in the title and escrow industry for 14 years.   She strongly feels that consumers should learn as much as possible about mortgages and the real estate process so they can make informed decisions.  She writes a nationally recognized blog, The Mortgage Porter and was recently named 2009’s Best Tweeting Mortgage Broker by the Seattle Weekly.