So, you’re a potential homebuyer with good credit but not much cash in the bank. You ask a lender to pre-approve you for a low down payment loan. The knee-jerk reaction of most lenders is to prepare you for an FHA loan.
That may not be the best choice anymore. Now, there is a conventional loan that can beat FHA for the homebuyer with good credit. It has lower mortgage insurance, and it has a lower minimum down payment – 3% as opposed to 3.5% for FHA.
Sound too good to be true? Well, try it yourself on the loan comparison calculator on our Web site. (Go to www.LoneStarLending.com and click on the “Compare Options” button.) Click the “Add option” button to get two side-by-side loan options. Let’s take a $150,000 home. For the first option, choose a conventional loan. For the second option, choose an FHA loan. Enter a 3.5% down payment for both options (so we’re comparing apples against apples). Use today’s interest rates, 5.0% for a 30-year, 97% conventional loan and 4.75% for a 30-year FHA loan.
Now, click the “Calc” button under each option. The most important number to look at is the “Effective APR” at the bottom of the results. This number takes into account your interest rate, the mortgage insurance, and your closing costs and amortizes them over the time you expect to spend in this home. If you’re an average homeowner, you’ll stay in this home less than 7 years. Notice that the conventional option is more than 0.2% lower than the FHA option. This is despite the fact that the interest rate on the conventional option is slightly higher.
The secret is the mortgage insurance. An FHA loan has both upfront mortgage insurance (1% due at closing) and monthly mortgage insurance (1.15% per year, paid as part of the mortgage payment). A conventional loan only has monthly mortgage insurance, and the annual premium is lower (0.88%) than for an FHA loan. Notice also that your monthly payment for the conventional loan is about $18 less than for the FHA loan.
Mortgage insurance is not your only savings with a conventional loan. Closing costs for conventional loans generally are a few hundred dollars cheaper than for FHA loans. (The calculator actually doesn’t take this into account.)
This comparison applies for homebuyers with very good credit. Those with a few dings on their credit still will benefit from an FHA loan.