How do you choose between Conventional and FHA approved financing when buying a new home? That’s a question your loan agent is more than qualified to answer. However, there are some general guidelines that indicate which way is probably more advantageous to each situation.
First and foremost, if you want to borrow more than $729,500 you have no decision to make; FHA backed funding is not available to you so you will be going the Conventional Non-Conforming route, also known as a Jumbo loan. These loans do not meet Fannie Mae and Freddie Mac guidelines meaning Fannie and Freddie will not buy them. Due to this they have a higher interest rate to make them more valuable and appealing to investors.
If you are borrowing less than $729,500, the type of financing you choose will depend very much on factors such as the life of the loan, the amount of down payment available and your credit history (primarily your FICO score).
The primary advantage of FHA loans is they allow buyers to finance more of the purchase, sometimes putting only 3.5% down. They are able to do that by charging an Upfront Mortgage Insurance Premium (2.25% of the base value of the loan) as well as a monthly Mortgage Insurance Premium. The UFMIP is typically paid at closing and added to the balance of the loan, however the buyer may choose to pay it out of pocket instead. The monthly payment varies from 0-0.55% as indicated in the table above. FHA lenders also tend to be more lenient when it comes to imperfect credit, such as late payments, open collections etc.
If you plan to put at least 20% down on your purchase giving a Loan To Value (LTV) ratio of 80% or less a conventional loan is probably going to be more advantageous due to the absence of a mortgage insurance premium.
There are some gray areas where it’s less clear which type of loan is more advantageous. For example if your LTV is 70-80% (20-30% down payment) but you have a lower FICO credit score (<660) you may find you get better payments with an FHA loan than going the conventional route. Conversely if your LTV is 80-95% but you have a strong FICO (720+) you may find that conventional is the way to go as the PMI rate may be better and there’s no UFMIP to consider.
When choosing between FHA and conventional you may also want to ask yourself what you could get if you paid 2.25 pts towards buying down the rate of a conventional loan as that’s how much you’re paying in UFMIP with FHA.
Once again, your loan agent can help you navigate through your options but hopefully this gives you some idea of why you’re being offered one type over another.