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Conventional Loans with Mortgage Insurance vs. FHA

Over the past few years there has always been a debate over which type of loan was better FHA or a conventional loan. With the advent of the recent FHA changes to more than double the cost of their monthly mortgage insurance, it is no longer difficult to pick the best loan, assuming you qualify for either one.

 

Below is chart provided by Radian Mortgage Insurance comparing FHA  and Conventional loans for a $250,000 purchase. The FHA loan requires 3.5% down and the Conventional loan requires 5% down. This chart is assuming you have a 720 credit score.

 

In this example, the conventional loan requires an additional $3750 down, but the monthly payment is $118 cheaper. After 2.6 years you would have recouped the additional $3750 in down payment in savings. In 6.3 years the mortgage insurance drops off (assuming 1% appreciation in home value yearly), and your monthly payment savings is over $240 vs. FHA. That's $50,000 in savings over the life of the loan!

 

Another advantage Convetional loans have is enhanced buying power. In the chart below, it shows you how much more home you can buy for the exact same payment.

 

In the example below, you can purchase a home $20,625 more expensive just because you chose to go Conventional loan vs. FHA and it's very high mortgage insurance.

Types of Fixed Rate Mortgages

 

30-year Fixed rate Mortgage

This conventional loan offers the lowest monthly payments in the fixed rate category.

 

Why This Loan?  People who plan to remain in the home for many years and want to keep housing expenses the same as long as they have the loan are likely to choose this loan.

 

15-year Fixed rate Mortgage

Because this loan has a shorter life 15 years vs. 30 years, the borrower pays less than half the total interest of a 30-year mortgage. However, because you repay the loan in half the time, the monthly payments are higher than those of a 30-year mortgage.

 

Why This Loan? For people who can afford the higher monthly payments, the 15-year fixed rate loan allows them to own their home before their children start college or before reaching retirement.Making Bi-weekly payments. With most 30- or 15-year fixed rate mortgages, borrowers can decide to make half the payment every two weeks instead of one payment each month. By doing this, you make the equivalent of 13 months of payments every year — without any increase in the total payment. Because these payments are applied to the loan every 14 days, the principal (loan balance) decreases faster, saving interest costs. A 30-year loan can be shortened to 18 or 22 years, providing a substantial decrease in the total interest you pay. If you decide to do this, you should do it all the time. Also, you must let your servicer (the company that collects your payments) know; otherwise the half payment may be applied as an extra principal payment — which also pays down your principal faster, but your full payment may still be expected on the due date.

 

  

Adjustable Rate Mortgages

 

Usually, adjustable rate mortgages (ARMs) offer a lower interest rate than a fixed rate loan at the start of the loan term, making the payments lower in the beginning and making qualifying easier. But the rate is “adjustable,” meaning it can go up or down based on a specific interest rate index (such as the U.S. Treasury Bill rate) plus an additional amount, called a margin. The dates these adjustments will occur are written in the loan documents, and they can result in significant payment increases. 

 

Rate caps at each adjustment date and over the life of the mortgage may offer some protection against sharp increases.  With an ARM, you and your lender share the risk of changes in interest rates. As a result, an ARM may offer an initial interest rate that can be as much as 2 to 3 percent lower than a similar fixed rate mortgage but can later increase substantially, covering the lender’s original risk.

 

Developed when interest rates were high, ARMs may still be a good choice for people who expect their income to increase, who don’t expect to be in their home for a long time and expect its value to increase, or who plan to refinance before the adjustment date occurs. However, because the interest rate can increase, you must have the resources to keep up with possible changes in your mortgage payment in case you can’t move or refinance.

 

Key Advantages: Most ARMs have lower initial interest and principal payments compared to fixed rate mortgages. If the rates have dropped when the loan adjusts, payments may be lower without refinancing.

 

Key Disadvantages: If rates increase, principal and interest payments increase.