When you compare mortgage rates, if you just look at conventional programs, you could be missing out on great deals. Depending on your circumstances, an FHA loan may cost you less, even if you have 10 percent, 15 percent, or even 20 percent equity in your home. Here's what you'll need to consider when selecting your next home loan.
- Down payment: FHA requires only 3.5 percent down, while most conventional programs require at least 5 percent. If your credit is not excellent, you will need mortgage insurance which isn't always easy to get. So your out-of-pocket investment is almost always higher with a conventional loan.
- Loan amount and property use: FHA mortgage amounts are limited depending on home prices in your county or metro area. FHA only insures primary residences, so if your mortgage exceeds the limit, or you are financing a rental or vacation place, FHA mortgages are not an option for you.
- Mortgage insurance: FHA borrowers always pay mortgage insurance, even if they have a lot of equity or a big down payment. Conventional mortgage lenders only impose mortgage insurance when they finance more than 80 percent of your home's value.
- Surcharges: Conventional lenders that offer Fannie Mae or Freddie Mac have to price according to the requirements of these companies. There are extra fees for credit scores lower than 740, for higher loan-to-value ratios, for condos, for investment properties, for manufactured homes, and for features like cash-out refinancing, adjustable rates, and interest-only payments. Jumbo mortgage lenders may not impose these charges, but their mortgage rates are generally higher. FHA borrowers don't pay these charges.
- Compare lowest mortgage rates for both programs. You can look up the surcharges on Fannie Mae's Loan Level Pricing Adjustment Matrix and see which ones apply to you. Understand that they are cumulative, so if you want a cash-out refinance to an 85 percent loan-to-value on a condominium and you have a 680 credit score, there will be surcharges for all of those things. You could end up paying several points or taking a higher interest rate. Charges on an FHA loan include an upfront mortgage insurance premium of 1 percent (which can be financed into your mortgage) plus an annual charge of .85 percent that's added to your monthly payment.
- Here's an example where a conventional loan is the better deal. You have at least 10 percent equity or down payment, excellent credit, and are purchasing a single family residence with a 30-year fixed-rate loan.
- An FHA loan might be better if.... You are refinancing and want to take cash out to 85 percent of your home's value. Your credit score is 690, which is pretty good but you aren't wearing a halo or anything. If your home is in Florida, many mortgage insurers don't want to do business with you, but FHA will.
The easiest way to decide is to have a couple of lenders price FHA and conventional financing for you. Be sure and give them an idea of what your credit score is, your home's value, and your loan amount. Tell them also the property type (condo, manufactured home?) and use (primary residence, second home, rental?). Then let the lenders do the work.