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There are many types of home loans that a buyer can apply for when looking to purchase a home. There are a few key down payment thresholds that can make a significant difference in the financing that you are looking to obtain. In this blog, I will review one scenario that if all facts line up as listed below could help you determine whether or not to go with FHA or conventional financing. Be aware while reading through this scenario that every single conventional loan is different. There are hundreds of banks and countless mortgage programs offered by those banks throughout this country; therefore, depending on the characteristics of that particular loan it could throw this entire scenario for a loop. Make sure you talk to a mortgage professional AND a financial advisor to make sure you are making the best financial decision for your situation. I am basing my numbers on what FHA has determined as the average price in Orlando of $157,000.

Although there are many down payment options, certain thresholds have greater benefits such as lower interest rate and/or mortgage payment. The three thresholds I will be discussing are 3.5%, 5% and 20% down payment amounts.

The 3.5% option is for those borrowers who do not have a large sum of money saved but still want to own a home. This option is the lowest down payment offered for borrowers looking to purchase a home (outside of down payment assistance programs, VA loans or USDA home loans all of which are for another blog post). These 3.5% down payment loans are available in the market place and are also know as 203(b) loans, HUD loans but most commonly referred to as FHA loans. Other than the difference in down payment what is an FHA loan ? According to the U.S. Department of Housing and Urban Development or HUD, it is a low down payment loan “funded by a lending institution, such as a mortgage company, bank, savings and loan association and the mortgage is insured by HUD.” FHA provides a set of guidelines to lending institutions and from there the lenders will make a credit determination based on the merits of each case.

There are also maximum loan amounts with FHA loans of up to $417,000 or less depending on the lender, location, and the buyer’s individual situation. Another major differentiating characteristic of FHA loans is the mortgage insurance that is charged to the buyer upfront and subsequently annually as well (paid monthly). The Up-Front Mortgage Insurance Premium also known as UFMIP and can be financed into the mortgage amount and is calculated as 1.75% of the loan amount. The annually paid premium is known as the Annual Mortgage Insurance Premium or MIP. On 30 year loans that are over 95.01% loan to value (LTV) the MIP is based on 1.35% of the loan amount; loans 95% or less the mortgage insurance premium drops slightly to 1.30% of the loan amount.

FHA-LoansNow UFMIP and MIP are not exclusive to FHA loans they can also be found in conventional loans. However, the general guidelines of the loans that UFMIP and MIP are applied to in FHA versus an Conventional are different. On FHA loans it used to be, at least prior to June 2013, that your mortgage Insurance would go away after the Loan to Value reached 78% or a maximum of 11 years. After June 2013, the rules changed and now FHA loans over 90% will have MIP for life. In addition, FHA loans that were previously exempt from MPI will now have to make payments for a minimum of 11 years.

For comparison of the two loan types (FHA and Conventional) we will assume the average Central Florida Home price of $157,000 at a 6% interest over 30 years. So although the down payment is low, those opting to take an FHA loan with an LTV 90% or more will be paying MPI for the entire length of their loan. In other words, the average Central Florida homeowner will be responsible for $2,119.50 a year made in 12 equal monthly payments of $176.62 for the life of the loan (typically 15 or 30 years). To put that in financial terms the mortgage insurance that previously cost $21,194.40 will now cost the 30 year homeowner $63,583.20. That’s a $43,388.80 difference in cost to the average homeowner over 30 years!

That is why I no longer recommend FHA loans for my home buyers unless they just don’t have any more money for their down payment. Instead, the buyer can opt to take a 5% down conventional loan where the buyer’s obligation to pay mortgage insurance will end after 120 payments or 10 years****. For the average Orlando homeowner that is a maximum payment of $21,194.40 and a SAVINGS of $43,388.80 over the FHA loan. In addition, the extra down payment will save the average Central Florida homeowner another $2,728.20 in interest over 30 years.

For my clients, I always recommend a 5% down conventional loan over the FHA loan (if they can qualify for it of course). The additional $2,355 in down payment today will save them an estimated $46,117.00 over 30 years.

Now, depending on the amount of down payment this advice will fluctuate. For example, FHA loans with a Loan to Value over 90% will have their MPI go away after 11 years or 132 payments very similar to conventional loans. Why is this important? Simple answer: interest rates. According to HUD and Freddie mac, over the last 22 years interest rates have averaged 6.02%** for FHA loans while the average rates on 30 year conventional mortgages have been 6.43%***. On the average Central Florida purchase of $157,000, that translates to a 30 year additional cost in interest of $15,055.20 for the average conventional loan over the average FHA loan.

Therefore, a client putting 10% down or more on their home purchase but not more than 20% is better off going with an FHA loan (assuming your time frames for mortgage insurance are the same as outlined above) because of the savings in interest over 30 years.

The interesting change in choice for those who are putting 20% or more is that with FHA loans MPI is still required for the first 11 years of the life of the loan or the $21,194.40 but it is not charged on most 20% down conventional loans. Therefore, for those home buyers that have the ability to put 20% down on their home loan even with the savings in interest rate that an FHA loan offers over a conventional loan you are better off going with conventional financing. This is because although in the first 11 years you will save $5,683.05 (given our $157,000 purchase price scenario with 20% down) in interest you will pay the $17,960.80 in MPI. Over 30 years in this scenario you will save $12,043.08 through the reduction in interest rate that the FHA loan offers over the conventional but you will have paid $17,960.80 in the mandatory minimums of MPI.

Therefore, if you put down 10% or 20%, you should avoid FHA loans if at all possible. If you put down 10% down but less than 20%, then you should consider using FHA financing to obtain your home loan.Conventional Loans

Remember, everyone’s individual scenario is different when you talk to your mortgage professional ask about current FHA rates and current conventional mortgage rates to compare both options if you are putting 10% or more down but less than 20%. Wait to purchase until you can save the additional 1.5% down payment for the conventional financing if you are not putting 10% or more down. In our $157,000 purchase price scenario that additional $2,355 in down payment could save you almost $50,000 in interest and MPI over 30 years. Some individuals will not qualify for conventional financing and must go with FHA financing if that is the case you will have to weigh out the options of refinancing the loan at some point to save the money on mortgage insurance but run your numbers as there is a point of no return (especially since you pay the bulk of the interest due in the first 10 years of your 30 year mortgage).

The scenarios above are hypothetical and you should have your real estate professional and financial advisor review your proposed mortgage paperwork to ensure that you are obtaining the best mortgage for your personal financial scenario. Also, remember that there are hundreds of lending institutions all offering different loan programs for buyers. These loan programs can change daily along with interest rates. There is a lot more to a mortgage than just this 30,000 foot overview and that is why it is so important to speak to your real estate and financial professional (not to harp 😉 ). Fortunately, I have some great mortgage professionals that I work with but even more importantly I work hand in hand with the Advisors of Global Asset Management Group to ensure smart financial decisions for my clients.

Learn More about the June 2013 U.S. Department of Housing and Urban Development
*Average Central Florida Homeowner purchase price is based upon the average $157,000 provided by HUD
**Average FHA Interest Rates : http://portal.hud.gov/hudportal/documents/huddoc?id=fharates_current.pdf
***Average Conventional Interest Rates: http://www.freddiemac.com/pmms/pmms30.htm
****Every loan is different make sure to confirm the specific mortgage insurance times on your loan with your mortgage broker or financial professional.