Is Conventional Better For Your FHA Buyer?

The deadline is in sight for the increase in FHA’s monthly mortgage insurance.  Any buyer trying to avoid the higher monthly premium should be in contract this week to get a case number assigned by the April 1^st change date.

Not all buyers will find their home this week though, and FHA is not necessarily the best option even if they do.  Many FHA approved buyers would actually be better offer using a 3% down conventional mortgage.

Wait – Buyers can use conventional financing with only 3% down?
Yes, they can.

Will it cost them more?
More than what?  More than a conventional loan with a larger down payment?  Yes, it will cost them more than that.  Depending on the market, the interest may be a touch higher (currently 0.125% more).  The monthly PMI will also be a bit more per month. 

But more than FHA financing?  Typically not.  The annual cost for PMI for a 3% down conventional buyer with a 740 credit score is over 0.5% less per year than for the same FHA buyer. 

So how do they compare side to side?

You want math?  Yea!  I love math.  Let’s compare some numbers: 

 In this chart, I'm assuming that your borrower is buying a $120,000 home with taxes of $1,200 per year and home insurance costs of $720 per year.  I'm also assuming that your borrower would qualify for a conventional loan with a credit score of 740 or higher. 

As you can see, with the conventional 3% down option the loan size, cash needed and monthly payment amount are all lower than the FHA option.  For the borrower who can scratch together the additional $1,800 in down payment money, the savings goes up even more.

What are the drawbacks of the 3% down conventional?

The biggest drawback of it is the impact of credit score.  The example above assumes strong credit.  If the credit score was 684 instead of 740, the interest rate would be 0.125% higher currently and the PMI would cost $12 more per month for the 3% conventional option, making the total 3% down conventional payment $5 higher per month than the FHA payment.  The cash needed would still be lower though, as would the loan size, so the conventional option is still the best choice.

Aren’t there additional drawbacks with conventional options?
There were in the last several years, but those are quickly fading as the PMI companies begin to get their flexibility back. 

Up until just a few months ago, most PMI companies were placing additional rules on the conventional buyer, including that that had to have 2 months of savings left after closing and a certain number of trade lines on their credit report.  The market is getting competitive again, though, and the PMI companies are responding by loosening these rules.  Currently, two of the four top PMI companies have removed these additional requirements, making it much easier to get approved for a conventional loan.

So what is this telling me?

Bottom line, not only COULD your FHA buyer likely go conventional, your FHA buyer SHOULD likely go conventional.  Many lenders won’t tell them about the 3% down option though, either because they aren’t aware of it or because they haven’t used it much and they’re not comfortable with it. 

Your buyer deserves to be working with a lender who will share with them the best options for them.  It’s your job to make sure that they are.  Feel free to forward this to anyone considering FHA financing for their home purchase along with my contact information (Lori Hiscock - lori.hiscock@ruoff.com) and I'll gladly help them compare their options to make sure they're getting the best terms possible for their home financing.