Friday, October 4, 2013

Let's Compare FHA vs. Conventional Mortgages Today

Today’s blog is a guest blog from Dan Hapner, the Director of Mortgage Sales at Meriwest Mortgage.

With home sales continuing to grow and the expectation that interest rates may be on the rise, let’s pause to consider the best loan products we might use for our next home purchase. FHA is a popular option for some families and I think it is important we understand the distinct differences between this form of government sponsored loan and a regular conforming conventional loan that is underwritten according to guidelines provided by Fannie Mae (Federal National Mortgage Association) or Freddie Mac (Federal Home Loan Mortgage Corp).

FHA Loans

The FHA, Federal Housing Administration, has been helping Americans own homes for 70 years. The FHA guarantees or insures home loans made by their qualified member lending institutions. This allows homebuyers to access a home without having to come up with a large downpayment. Typically, conventional mortgages require a 20% downpayment. FHA guaranteed mortgages can be made with as little as 3.5% downpayment! That downpayment can be 100% gifted to the borrower. There is no “seasoning” requirement of having the funds on hand 90 days prior to the purchase.

FHA guaranteed loans can be adjustable or fixed. They also have two graduated payment programs that can help families get into their first home at a reduced monthly payment that will grow as their income grows. Most of the FHA guaranteed loans are made at a fixed interest rate and is typically lower than a conventional loan.

How does it rate as a first time homebuyer loan? Not bad, but the news is not all good either.

The Good: FHA requires a FICO score of 580 for the 3.5% low downpayment program.

Many participating FHA lenders require a FICO score of at least 620 in order to qualify for an FHA home loan. Just because the FHA minimum is 580 does not mean a particular bank is willing to issue credit to those with that score--the FHA loan program is a voluntary one, lenders are not required to participate, and the FHA cannot force the bank to lower its FICO requirements. These FICO scores are significant as most conventional loans require a FICO score of 680 or better. Another advantage for FHA is the maximum loan limit is $625k vs. $417k for a conventional loan. FHA maximum’s are increased in areas with high priced housing such as the San Francisco Bay Area to $729,750. FHA loans often allow for a higher debt to income ratio, making more borrowers eligible.

The Bad: For most FHA loans, the sellers will pay the closing costs. This can be an impediment to selling to a particular buyer if they intend to use an FHA loan. Closing costs can be very expensive for the seller and make an FHA loan difficult to use for the buyer. This is particularly true in the case of a short sale home if the sellers don’t have a lot of cash on hand or equity. The sellers need to be flush with cash or equity in the case of a buyer with an FHA loan.

First time homebuyers need to be aware of the costs involved in using an FHA loan to finance your home purchase. As the loan is not a conventional loan, it is going to require mortgage insurance. FHA mortgage insurance will cost the buyer 1.5% of the total loan amount upon closing and then 0.5% of the loan each year to pay for the mortgage insurance. On a $400,000 loan that would mean a mortgage insurance cost of $8,000 in the first year; the upfront insurance payment of $6,000 at closing and then $2,000 the first year in annual premiums. The mortgage insurance stays in effect for the life of the loan. The only way to eliminate the insurance is through paying off the loan or through refinancing.

Another issue involved in FHA lending is the approval of the property. The property must meet FHA standards. If the collateral is not up to FHA standards, the seller must pay for repairs. This can be an impediment for sellers with homes that need a little work. If a house is being sold “as is,” it may not be a good target for an FHA type loan.

Time is also a factor. FHA loans typically take longer to process than a similar conventional loan.

Conventional Loans

Most of the mortgages made in the United States are conventional mortgages. These are used for purchase and for refinancing an existing loan. They can be an adjustable loan or a fixed rate type of loan. As most lending institutions offer conventional home financing and set their own interest rates, borrowers can have a wide range of lenders and interest rates from which to choose. FHA loans are limited to approved lenders.

Generally, conventional mortgages require a 20% downpayment for home purchase transactions. A purchase with less than 20% down would require private mortgage insurance (PMI) be paid for by the applicant. PMI generally costs 1% of the total loan amount annually. The insurance payment is usually included with the loan payment. A $400,000 mortgage that requires PMI would have a charge of $4,000. That would add $333 to each monthly payment.

Conventional loans also require an applicant have a 680 or better FICO score. This is higher than an FHA loan, but less than is required for most consumer loans which is 740.

There are fees involved with conventional loans, such as processing fees, application fees, and appraisal fees. But if one is willing to pay a slightly higher interest rate on their loan, they can avoid fees altogether. By paying an additional point or one percent of their loan amount upon closing, they can pay down their loan interest rate and possibly save themselves thousands of dollars over the life of the 30 year loan. Conventional loans have a lot of options when it comes to interest rates and fees.

There are local government and non-profit programs that can provide some downpayment assistance and thus decrease the downpayment needs. As an example, Meriwest Mortgage works with the Housing Endowment and Regional Trust in San Mateo County, HEART of San Mateo. They offer homebuyers up to $78,225 in downpayment assistance and that can offset up 15% of the purchase price with just 5% down. These downpayment assistance programs can be used to eliminate the need to pay for mortgage insurance and can be very helpful in making a home purchase more affordable for first time homebuyers.

As conventional loans are offered all across the country in every municipality, there is a great many lenders from which to choose. Competition is your friend and keeps fees down and processing times speedy. Most of the HEART Program loans are processed in less than thirty days and are often completed and closed in only 20 days!

As we saw with the need to provide PMI in cases of small downpayments, there are some warts on conventional loans. As these loans are sold on the secondary market to Fannie Mae and Freddie Mac once processed and booked as a mortgage backed security, borrowers have fewer options in regard to default. What this means to a borrower is the issuing lender does not own the loan and thus has no control over the default process and cannot make arrangements with the borrower to reduce interest rates, payment forbearance, etc. Currently, these borrowers are being encouraged to take part in the HARP and HAMP Government Programs to help families in foreclosure.

In conclusion

Let’s keep in mind that the United States Government does not make home loans. They guarantee or insure home loans. What this means is the lender is insured against loss by default of the borrower. It does not insure the borrower or guarantee the borrower against default in any way.

Do you have more questions about a future home purchase or a refinance of your existing loan? Please contact Dan at

Meriwest Mortgage and Meriwest Credit Union are Equal Housing Lenders.
Meriwest Credit Union deposits are insured up $250,000 by the NCUA

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Our next set of workshops will be taking place at our Sunnyvale Financial Center at 563 E. El Camino Real in Sunnyvale, next to Togo's Sandwiches. To attend, please RSVP with Greg Meyer at or 408-365-6328.

Auto Finance 101 - Learn the in's and out's of purchasing a car. Research your car and your financing. Learn how to make the deal and avoid dealer tricks. Negotiate your purchase price, interest rate, and terms.
6:30PM - 7:30PM on Oct. 16th
Sunnyvale Financial Center

Credit Myths and Repair - Learn how to access your credit report from all three credit bureaus and your credit score for free. How do inquiries effect your score? What happens to your credit after you pay a collection? Have a late payment? Get a divorce?
6:30PM - 7:30PM on Oct. 23rd 
Sunnyvale Financial Center

Meriwest Credit Union
 November 9th and 10th at the Meriwest Credit Union Main Office 
5615 Chesbro Ave, San Jose CA 95123
Come to see our wide selection of late model, gently used cars offered at bargain prices by our MCU approved dealers.

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