[ Edited ]
al vs. FHA (VA & USDA)
07-20-2010 10:51 AM - edited 07-20-2010 12:47 PM
Choosing between conventional & FHA financing isn't always clear, there are many factors that need to be taken into consideration. Below I will go over a few points.
Conventional comes in two forms: conforming & non-conforming. Conforming means it meets Fannie Mae's & Freddie Mac's guidelines, non-conforming does not meet those two quasi-government company's guidelines. The most distinct difference is when you are financing a mortgage amount that exceeds the conforming loan limits. Conforming loan limits are $417,000 and can be higher in high cost markets (NYC, LA, SF, Boston, etc.), anything over the conforming loan limit is considered a non-conforming loan amount and thus needs non-conforming financing. Conforming financing is offered by pretty much any mortgage lender, non-conforming financing is tougher to find and by today's offerings the rates can be approximately 1-2% higher. These days conforming financing is split up between two categories as well, "regular conforming" and "conforming jumbo". The regular conforming loan programs are for loan amount of $417,000 and under, and the conforming jumbo programs are for those high cost areas which have higher conforming loan limits. Conforming jumbo guidelines are more restrictive in terms of credit score, down payment requirements and debt to income ratio. The difference between those two conforming sub-category rates is often between .25% to .50%.
FHA financing also has a maximum mortgage limit, in all areas it's at least $271,050, and then in higher cost areas it increases from there.
To check the conforming & FHA loan limits the official website is https://entp.hud.gov/idapp/html/hicostlook.cfm. On the "Limit Type" drop down menu is where you select "Fannie/Freddie" or "FHA Forward".
FHA loans have monthly mortgage insurance unless the term is 15 years or less and the loan-to-value is 90% or less. For terms longer than 15 years the amount of the mortgage insurance is .55% (.5% if the loan-to-value is 95% or less) of the base loan amount per year, for terms 15 years or less and loan-to-value over 90% it's .25% of the base loan amount per year, both are paid in monthly installments as a portion of the mortgage payment. The monthly mortgage insurance needs to be paid for at least 5 years and also until the loan amount reaches 78% of the home's value at the time the loan was made (not current value). Will you have mortgage insurance on the proposed conventional loan? If so, what is the rate of the mortgage insurance for the conventional loan?
FHA loans also have an upfront mortgage insurance premium (UFMIP) equal to 2.25% of the base loan amount, which can be paid out of pocket or financed into the loan amount (most people choose to finance it). So you should consider if you paid 2.25% in origination/discount points on a conventional loan - what would your interest rate be?
Usually if the loan-to-value is 80% or below, conventional financing wins out pretty much every time. There are exceptions, such as the situation with a lower FICO score (below 660) and loan-to-values between 70-80% where interest rates for conventional loans can become significantly higher than their FHA counterpart. But when considering the UFMIP that FHA charges conventional still has a slight advantage.
When loan-to-value is between 80-95%, and with strong (720+) FICO scores, conventional often is the better bet due to the competitive mortgage insurance rates vs. FHA, plus there is no UFMIP fee like there is with FHA. Loan-to-value between 80-95% with 660-719 scores, conventional starts to lose it's competitive edge since the mortgage insurance rates increase vs. FHA's. Above 95% loan-to-value FHA becomes the better choice due to the inability to obtain mortgage insurance with conventional financing.
FHA is also more lenient on imperfect credit, allowing collections/charge-offs to remain open/unpaid (this is up to lender discretion however), late payments on consumer debt (auto, credit cards, etc.), and even a mortgage late payment or two, whereas conventional financing may not approve spotty credit. This is particularly true when the loan-to-value is over 80% when conventional financing requires mortgage insurance, as the mortgage insurance provider also underwrites the loan in addition to the lender, and mortgage insurance underwriting guidelines are pretty strict (even more so than lender underwriting).
Lastly, FHA permits higher debt to income ratios than conventional financing does. So overall FHA is more lenient, but there are situations where a borrower does not need the leniency to get approved for a mortgage, and that is where conventional gains the edge.
When evaluating conventional vs. FHA it's good to get a payment breakdown along with a fee estimate, so you can see how the overall loan is affected.