Jim's Credit Corner - August 11

Dear Jim,

What are the benefits of getting an FHA loan versus a FNMA Conventional loan for a purchase? I believe both offer low down payment options, so why would a lender suggest one over the other? Thanks for the clarification.

— Virginia Brown,  Keller Williams Realty

Hi Virginia,

This is a great question and there are many reasons why one loan option would be recommended over the other. Without looking at the borrower's overall financial situation, existing loans, etc., I can share some of the highlights of both loan products. As always, I encourage borrowers to reach out to their lender and they can provide them with the many loan options available.

First, a little background on each loan program.

The Federal Housing Administration (FHA) was created through the National Housing Act of 1934 to help revive and stabilize a housing market and many first-time home buyers or credit challenged borrowers use FHA loans. FHA loans require occupancy by the borrower and are not used for second homes or investment properties. The maximum loan amount for FHA in Mesa County is currently $314,827.

Conventional loans are not insured by FHA or guaranteed by VA. Also known as conforming loans, they are available through Federal National Mortgage Association (FNMA) and Federal Home Loan Mortgage Corporation (FMAC). The maximum loan amount in Mesa County is currently $484,350. When the loan amount exceeds these limits, the loan is then "non-conforming" or a "jumbo" loan.

If your loan is going to exceed $314,827, then a conventional loan would be your only option when comparing these two loan programs.

In the past, FHA loans were a great option for a low down payment of 3.5 percent. However, FNMA offers a HomeReady program with a 3 percent down payment option. Effective the weekend of July 20, FNMA is reducing the HomeReady income limit to 80 percent of the area median income for all areas, which means the maximum income to qualify for a HomeReady program is $51,120 in the Grand Junction area. This can vary by area, so your lender can provide you the income limits for other cities and counties. If your income exceeds this amount, the minimum down payment on a conventional loan would then be 5 percent.

Mortgage Insurance is different for each loan program. For FHA, all mortgages are charged a 1.75 percent mortgage insurance premium (MIP) which can be added into the loan amount. You are also charged an annual MIP of .85 percent or .80 percent if you apply at least a 5 percent down payment. No matter your FICO score, the Mortgage insurance premiums are the same. Mortgage insurance on conventional loans are usually paid upfront, paid monthly or sometimes it is lender paid which is included in the interest rate, and most important, it is based on your FICO score. The higher your FICO score the lower your mortgage insurance on a conventional loan.

Here is an example of the difference between the two loan options. Let's say your FICO score is 720 and you are purchasing a home for $300,000 and you would prefer to go with the minimum down payment.

FHA – 3.5 percent down payment ($10,500), loan amount is $289,500, plus MIP ($5,066.25) = total loan amount of $294,566.25. At an interest rate of 4.25 percent, your principal and interest payment would be $1,449.09. But you also pay a monthly MIP of $208.65, so your total payment (not including taxes and insurance) would be $1,657.74.

Conventional – 5 percent down payment ($15,000), loan amount is $285,000. At an interest rate of 4.25 percent, your principal and interest payment would be $1,402.03. Because your FICO score is 720, your estimated monthly mortgage insurance would be $137.75, so your total payment (without taxes and insurance) would be $1,539.78 or a savings of $117.96 per month compared to an FHA loan.

Most important, the mortgage insurance on the FHA loan remains for the duration of the loan. On a conventional loan, the servicer must automatically terminate your mortgage insurance on the date when your principal balance is scheduled to reach 78 percent of the original value of your home. And if you apply a large payment and/or your house appreciates before that time frame, some servicers will remove the mortgage insurance earlier if you can validate that your mortgage balance is at 80 percent or less than the value of your home. This is usually done by having an appraisal completed.

The above options did not take into consideration other loan programs that may make more sense for the borrower, such as VA, USDA or CHFA loans (down payment assistance). The interest rates and mortgage insurance rates were only examples and your lender can provide you pricing specific to your situation.

Again, I encourage borrowers to reach out to their lender and they can provide them with the many loan options available. Thanks again for a great question!

Jim Kaiser

Branch Manager,

NMLS #1721861

Cherry Creek Mortgage

Jimkaisermortgages.com

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