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8 Low Money Down Conventional Loan vs. FHA Loan

Which Home Loan Program Is Better for You?

Buyers hunting for a low down payment mortgage loan with the lowest possible interest rate have two particular options available worth exploring in detail:

  • FHA (Federal Housing Authority) loan with 3.5% down
  • Conventional 97 loan with 3% down

Which is better? Let's take a close look at both the FHA and conventional mortgage product:

The FHA 3.5% Down Payment Loan

FHA is not a lender. It is a federal agency that insures mortgage loans. Its history spans to the 1930s when it was very difficult to get mortgage loans. Terms at this point in the Great Depression were outrageous for most borrowers; one had to pay off the loan in 60 months or less and down payments were as high as 50%!

That is when the FHA came into being. It established a new program that insured US mortgage lenders against defaults on loans, and offered favorable lending terms to many borrowers.

Today, FHA low money down loans are available to borrowers with average credit scores for up to 30 years and down payments as low as 3.5%. FHA mortgage rates often beat the market average by a ΒΌ point or more.

FHA has certain requirements to enjoy these benefits:

  • Income must be documented and verifiable
  • Home buyers must pay for mortgage insurance (MIP) each month, for the life of the loan

MIP will vary depending upon the type of loan and amount you put down. Most often, home buyers select a 30 year, fixed rate FHA loan with a 3.5% down payment. They pay .85% against the borrowed amount in insurance premiums. This adds up to $71 per month for $100,000 borrowed.

FHA loans are very popular: Approximately one in four loans are insured by FHA in the US.

About the Conventional 97 Loan

This is another low money down mortgage loan that is very attractive. The new version of this conventional loan is available to both first time buyers and repeat home buyers. A first time homebuyer under this program is someone who has not bought a home in the previous 36 months.

So, a person who lost a home in a foreclosure in the last 10 years can qualify.

Also, the Conventional 97 loan program offers just a 3% down payment. Only 30 year fixed rate mortgages are offered and the loan has to be for your primary residence.

You also must purchase private mortgage insurance because you have less than 20% equity in the home. However, PMI cancels when the loan hits 80% LTV.

Which Home Loan Program Is Better?

As with most things in the mortgage world, it just depends upon your circumstances:

Credit

Credit scores matter a good deal. An FHA house loan is available to borrowers with credit scores as low as 580. A conventional home loan requires at least a 620 credit score. So, if your credit is under 620, you really must get an FHA mortgage.

When your credit score increases, a conventional loan becomes more attractive. Your rate will drop as will your PMI costs. With FHA, your rate and insurance costs are the same regardless of your FICO score.

So, over the long haul, a borrower with above average to excellent credit will often find that a conventional loan is more attractive and economical.

However, in the short term, FHA is the better option much of the time.

Consider: If your loan is $250,000 and you have 2016 mortgage rates, an FHA loan is going to be 10% cheaper for a borrower with great credit above 700. For a borrower with lower credit, the FHA option is 25% cheaper.

That does not mean the FHA loan is always the best:

How Long Will You Stay in Home?

This is a critical factor in determining which loan is better. Remember, FHA mortgage insurance lasts for the life of the loan, but Conventional 97 insurance goes away when you hit 20% equity. So, over many years, the conventional loan may become a better value, especially with a high FICO score.

If you think you will stay in the home less than five years, an FHA loan probably is a better short term bet. But how many people know for certain how long they will stay in a home? We often think we will stay in a house for 20 years, but then things change, or mortgage rates decrease and we can refinance.

Here is a good general rule of thumb: If housing prices are generally rising and you want to stay in the same home and mortgage for more than six years, a Conventional 97 loan may be the most economical.

Also consider:

Upfront Fees

FHA charges for two types of mortgage insurance. The first is built into your monthly payment and is described above.

The second is paid at closing and is called Upfront MIP. It costs 1.75% of your loan's borrowed amount and is added to the balance.

The Conventional 97 program charges no such fee.

The Bottom Line

The FHA low money down program may be best for short term scenarios for people with average to below average credit. Meanwhile, this Conventional loan program may be better suited for borrowers with better credit and plan to stay in their home for a long time.

 

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