Today in California, fewer than one-third of homes are sold to first time home buyers. That’s the smallest percentage in decades. But now HUD has dropped the PMI rate (private mortgage insurance) on FHA loans, the mortgages taken out by most first time buyers. So when comparing FHA vs. Conventional mortgages, which is better?
FHA loans are popular because they only require a down payment of 3.5% with a credit score of 580. The down payment doesn’t even have to be your own money – you can use a gift from friends or family. And sometimes home sellers, builders, or even lenders to pick up the tab for closing costs and other fees.
Sounds great, right? A conventional loan still clearly has it’s advantages while FHA loans have some obstacles in front of it:
1. The maximum sale price to obtain a FHA loan in San Diego County is currently $612,950. Two mortgage insurance premiums are required on all FHA loans: 1. The upfront premium is 1.75 percent of the loan amount. This equals $1,750 for every $100,000 of loan amount. 2. The annual premium (but normally paid monthly with your mortgage payment) is as follows:
2. Banks are very picky. Buyers can help themselves by having up-to-date tax returns, W-2’s, 1099’s and the last three months of bank statements. But it’s not just the paperwork, it’s also your FICO score. While FHA loans technically require a credit score of 580, most lenders won’t consider buyers with credit scores under 640. (Conventional loans normally require FICO scores of 700 and higher).
Part of the reason for this? Since FHA loans only require 3.5% down. This limits home buyer risk, since they don’t have much “skin in the game.” If the housing market goes into another steep decline, these homeowners are more likely to walk away, leaving banks high and dry.
3. FHA loans are still more expensive than most conventional loans. The FHA took a big hit during the housing collapse and required a $1.7 billion bailout in 2013. Those losses led to an increase in the fees charged for FHA loans.
But for borrowers with a higher FICO score, it’s more economical for them to get a conventional loan and pay the PMI, or private mortgage insurance. This is because in addition to FHA’s monthly fees, there’s an upfront charge of 1.75% of the loan amount. So if you took out a $200,000 FHA loan, the loan amount you’d pay back would be $103,000. This is in addition to the monthly PMI payment on the loan of (currently at the new lowered rate of .85%/year).
4. On conventional loans: once a homebuyer has accumulated enough equity to equal 20% of the home’s value, they can request that the mortgage insurance be cancelled. On FHA loans, PMI remains in place for the life of the loan. Thus the only way to get drop it is to refinance into a conventional loan, or sell the home.
About Me: I am a full time agent and I dedicate 100% of myself and my time to my valued clients in addition to the San Diego communities that I serve. It is imperative that I continuously evolve with local and national trends in addition to always looking ahead of the industry. It is a must to always provide the best service to my clients, their families and friends.