Have you ever wondered what the difference is between an FHA loan and a conventional loan? There’s no better person to ask than our most-trusted mortgage adviser, Bob Johnson (AKA BobMortgage). Frequently asked questions usually center on how the loan type affects appraisals, down payments, and debt-to-income ratios. How does it affect mortgage insurance, and all of the little hurdles that make up a very complex transaction?

Find out today in the 28th episode of the BobMortgage Zone from the senior mortgage adviser at the nation’s oldest private lender, Wallick & Volk

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 For decades, it was a pat answer. If the borrower’s home mortgage application had a little ugly around the edges, push them toward an FHA loan.

That’s because FHA loans would accept all of the hard cases that made conventional mortgage lenders turn up their noses. From wee down-payments and less-than-pretty credit to iffy loan-to-value or debt-to-equity ratios, FHA loans were the very best bet.

That may not be the case any longer, says my friend Marcus McCue, Senior Vice President of Guardian Mortgage Company.

Have FHA loans grown hairy legs, gotten more expensive, or have conventional loans become cheaper? What’s happening here?

It’s actually both. Thanks to all the fun we had during the real estate boom, and loosey-goosey lending practices, we consumers get spanked. FHA mortgages now require a mortgage insurance policy (MIP) that costs 1.75% upfront, compared to the past rate of just 1%. Plus, FHA loans also now require an annual MIP payment of 1.2% for a 30-year fixed mortgage (assuming the buyer made a down payment of 5%). Together, these MIP payments are pushing the cost of FHA loans up considerably.

Another past advantage of FHA mortgages was that they allowed family members to provide a down payment, while conventional mortgages did not. Now, however, most conventional lenders are allowing 100% of the down payment from family members, putting both types of loan on even footing in this regard.

Question: Is there some magic number for a borrower’s credit score where they will be better off financially with a conventional mortgage?

Borrowers with scores as low as 660 will, in most situations, find conventional lending to be cheaper. Mid-credit-score borrowers of 720 or greater will save quite a bit by going the conventional route.

Question: Can you give me a real-world example of the difference between FHA and Conventional loans today?

Yes. This example is based on an actual analysis we recently compiled for a borrower. We looked at a home that was $213,500 with 3.5% down (FHA loan) and 5% down (FHA & Conventional). In addition, we looked at a 3.75% rate and a higher 4.125% rate on the conventional loan (as if the borrower was a poorer credit risk) and the conventional loan was still a better choice because there was no MIP.

Money Down Estimated Monthly Payment

3.5% down (FHA – 3.75% rate) $6,394 down, $1,735 monthly payment

5% down (FHA – 3.75% rate) $9,670 down, $1,708 monthly payment

5% down (Conventional – 3.75% rate) $9,919 down, $1,603 monthly payment

5% down (Conventional – 4.125% rate) $10,214 down, $1,533 monthly payment

In the two highlighted examples, the difference between the FHA and the Conventional loan is approximately $37,500 over the course of the loan. In the last example, the lender paid the mortgage insurance rather than the homeowner, which made a difference of over $63,000 over the course of the loan.

Question: If I want to compare a conventional loan vs. an FHA loan for myself, where can I go?

There are some excellent online calculators that will help borrowers and their agents determine which flavor of loan works best in their situation. Check out the online calculator from Radian. For your comparison, select “Borrower-Paid-Monthly (BPMI) Non-Refundable” for a conventional loan. Then you can select the other products you’d like in the comparison.

If you’re an agent looking to help a client, then you may want to delve into the issue a bit more. These sites have FAQs and more technical information:

• Genworth – Conventional PMI vs. FHA resource center

• Radian – Conventional PMI vs. FHA Frequently Asked Questions

• MGIC – Conventional PMI vs. FHA Sheet

If you have additional questions about your particular situation, feel free to contact Marcus McCue at 972-200-3380, marcusmccue@gmc-inc.com or on Facebook.

 

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So with rents averaging around $1000 for a two-bedroom apartment in the Metroplex, it is almost cheaper now to buy than rent. Does this have the troops stirred up about home- buying again? Yes…maybe. More agents are telling me how the market for first time homebuyers is picking up in Dallas. I went north to Plano and talked with André Kocher of Keller Williams and Wade Betz of Guardian Mortgage Company about the new, more fiscally conservative homebuyer coming in for loans.

Candy: We’ve seen the good news that home sales continue to rise in our area, the investors are loving Dallas, but who are these new homebuyers? Do they really exist?

André: They do! By and large, they are a more conservative and cautious group. They are interested in buying a home because the historic low rates mean they could own for less than they are renting. However, they want to make sure they don’t get into trouble down the road.

Many of our clients have studied Dave Ramsey and are practicing his tenants. (Editor’s note: Dave is a financial media guru who teaches followers to have a zero tolerance for debt.) They are out of debt or working to get out of debt. They are saving up higher down payments – around 10% for conventional loans – and they are interested in 15-year mortgages. Many are keeping their mortgage payments to 25% or less of their monthly income.

Candy: That means they are buying smaller homes. Surely not every homebuyer is so well-behaved fiscally speaking?

André: Of course not. There are still folks who want to buy a house bigger than they can safely afford or who have a lot of debt hanging over their heads. In cases like this, my wife Kelli and I will often take them aside and talk to them about getting out of debt first, or looking at a less expensive home – to get their financial house in order before applying for the loan. We’ll even direct them to a Dave Ramsey course, if they are interested. We want them to be successful, not disappointed.

Candy: André mentioned 15-year loans – is there really that much difference between 30-year and 15-year loans when the rates are so incredibly low to begin with?

Wade: Practically no one would be upside down on their mortgages right now if everyone had a 15-year loan. It is the best “forced savings” plan you can do for your family. Not only are the rates lower for a 15-year loan, but you are paying down principal – fast. Seven years in a 30-year loan and you’ve barely touched your principal. Seven years in a 15-year mortgage, and you’re halfway done.

Candy: Wowzers. What about getting a 30-year mortgage and then making extra payments?

André: The biggest problem with that approach is that people start off with good intentions, but rarely have the discipline to keep up with the payments and they are paying at a higher interest rate. If they can afford the higher monthly payments, they really should get a 15-year loan.

Candy: How much higher do 15 years cost on average?

Wade: About 50%. On a $100,000 home you might pay around $1,000 a month with a 30-year loan and $1,500 with a 15-year loan. From what I can tell, homebuyers are getting the message. In 2011, 15-year loans made up 37% of my conventional loan portfolio – a huge jump from 8% in 2010.

Candy: Speaking of rates, what are the latest rates?

Wade: Earlier this month (Feb.) we closed conventional loans at 3.25% for a 15-year loan and 3.875% for a 30-year loan. Rates like these are not going to last indefinitely.

Candy: What about investors? Are you seeing the same kind of conservative approach from them?

Wade: It depends on why they are buying the house. A younger investor who is planning to rent the home – and boy is this a great time to be a landlord – will generally go for a 30-year loan for cash-flow purposes. Since the tenant is paying the mortgage, the investor is less sensitive to the higher rate. Investors generally put in as little as they can – 20% down is the minimum required.

An exception to this is an older investor who is looking to cash out his properties and retire. This investor wants to own the home faster and plans to sell when the market has recovered. He may put down a higher down payment – there’s a price break at 25% down – to speed up the process and get a 10-year or 15-year loan.

André: Investors have to be in even better financial shape than regular homebuyers to get a mortgage. I tell my clients who are new to this that they are entering a business venture with the bank. They have to prove that the property will pay for itself and that there’s enough revenue to cover the mortgage. If your tenant leaves unexpectedly, can you pay the mortgage for 2-3 months while you find another one? What if rental rates drop 10%? Can you still pay the mortgage?

Candy: Thanks guys, I agree it’s a great time to be a landlord. Unfortunately, the costs of home ownership are about to go up!