10 differences between FHA and conventional loans?

Home buyers closing on their mortgageWhich loan is best, conventional or FHA? It depends on your income, credit score, employment & assets and other differences between the two mortgage loans. Did you know you that you can borrow more money with a conventional mortgage? And that the FHA loan requires a minimum credit score of 500?

I know that this mortgage stuff is confusing. But, you should be congratulated for taking a few minutes to determine which mortgage loan is best for you. After all, you will probably make a monthly payment for the next 30 years. Here is comparison of the FHA and conventional home loans.

(1) Federal Backing

The FHA home loan is insured by the Federal government. This means that if the homeowner defaults on the mortgage, the government will reimburse the lender for a (percentage) of the loss. Because of the federal backing, home lenders are able to extend mortgages to home buyers and homeowners who desire to refinance their existing mortgages that may not be able to purchase a home or refinance because of their credit score, employment history or other conditions required for a home loan.

The FHA purchase and refinance guidelines are better for credit challenged borrowers.

(2) 2018 Single Family Loan Limit

The loan limits are set by Congress each year. There are some county exceptions, here are the typical lending limits for most US counties. For a home buyer seeking to purchase a $500,000 home, the FHA home buyer will need a larger down payment than the buyer purchasing the home with a conventional mortgage.

FHA - $294,515
Conventional - $453,100

(3) Cash Reserves

The conventional loan is likely to require a home buyer to have at least two mortgage payments in cash reserves after closing in addition to the required cash at settlement.

Liquid assets that can be used for reserves include, checking or savings accounts, investments in stocks, bonds, mutual funds, certificates of deposit, money market funds, and trust accounts, the amount vested in a retirement savings account, and the cash value of a vested life insurance policy.

The total cash reserve requirements is determined by the automatic underwriting system. The purpose of the cash requirement is to make sure the home buyer can take on a sudden emergency after settlement and still be able to make the mortgage payment.

The FHA mortgage does not require any cash reserves.

(4) Credit Score

The FHA permits a 500 credit score with a 10% down payment, and 580 with the minimum down payment of 3.5%.

The minimum credit score defined in the Fannie Mae for a fixed rate mortgage is 620. For adjustable rate mortgages, the minimum credit score is 640.

(5) Down payment requirement

The FHA requires a 3.5% down payment, currently, the down payment requirement for a conventional loan is 3%.

(6) Interest Rate

The FHA interest rates tend to be lower than the conventional interest rates. The reason is due to the risk associated with the conventional mortgages. FHA mortgages are "insured" by the federal government, because of the federal insurance, there is less risk.

(7) Monthly Mortgage Insurance

The FHA loans require a monthly mortgage insurance premium, regardless of down payment. That's right, even if you have a down payment of 20%, you will have to pay a monthly mortgage insurance payment with your principal and interest payment. And get this, it never goes away. It doesn't matter how much equity you have in your house, that monthly cost will be there. The only way to get rid of it is to refinance out of the FHA mortgage.

The conventional home loans also charge a monthly mortgage insurance premium on loans with less than a 20% down payment (or equity, for refinance loans). But, the monthly mortgage cost goes away after the loan is paid down to 78% of the original loan amount or you can ask the lender to remove the pmi when you have paid down the mortgage balance to 80% of the home's original appraised value.

The mortgagee insurance premiums are set by the private mortgage insurance companies. The monthly percentage cost is based on credit score, down payment (or equity), and other adjustments, such as whether the property is a second home, loan amount greater that $500,000, etc. It should be noted that the PMI companies also offer single payment plans and plans that require an upfront payment, but a lower monthly payment.

(8) Upfront Mortgage Insurance

The FHA loans require a mortgage insurance premium that is paid in full at settlement. The "upfront" mortgage insurance premium percentage changes periodically. As of January 26, 2015 the up front mortgage insurance premium is 1.75 percent on the base loan amount. On a loan amount of $100,000, the additional cost is approximately $1,750. The up front mortgage insurance premium can be paid in full at settlement or can be financed in the loan ($100,000 + $1,750 = $101,750). Learn more about the upfront FHA mortgage insurance

The conventional loans do not require an upfront mortgage insurance cost.

(9) Maximum Loan Amount

Conventional mortgages have a higher loan limit than FHA mortgages. Loans that exceed the loan limits are known as jumbo mortgages.

(10) Seller Paid Closing Costs (seller assist)

Home sellers are allowed to pay a percentage of the buyer's closing costs with FHA, VA, USDA and conventional loans. The difference between the loan programs are the total allowable concession. The conventional mortgage rules permit the seller to pay up to 3% of the sales price toward the buyer's closing costs with a down payment less than 10% (i.e. 3% or 5%) down. With a down payment of 10% to 24%, the seller is permitted to pay up to 6% of the sales price to the buyer's closing costs, and if the down payment is 25% or more, the seller can pay up to 9%.

The FHA allows the seller to pay up to 6% of the sales price, regardless of the down payment. Obviously, for cash strapped home buyers, the FHA mortgage is a preferable choice. Learn more about seller paid closing costs

So which mortgage is better? Each applicant is different. For the cash strapped and credit challenged home buyer, the FHA is the better choice. But, if you have a high credit score and sufficient cash, then the conventional mortgage is likely the better choice.