Government sponsored loan programs, such as FHA loans, have been getting a lot of press lately. But, how does an FHA loan differ from a conventional loan? What are the advantages of each?
The Federal Housing Authority (FHA) was created in 1934 to help potential homeowners gain access to money to boost homeownership rates throughout the United States. FHA loan programs require very little money down on a new purchase (usually only 3% of the purchase price) and will lend up to 95% of the value of a home on a cash out refinance. This high loan-to-value ratio is the primary appeal of an FHA transaction.
The FHA is not a lender and does not actually make or guarantee home loans. They insure the loans an online mortgage lender can assist you in obtaining.
FHA currently only offers three loan programs:
30 year fixed
15 year fixed
5 year fixed ARM
FHA Mortgage Insurance Premiums (MIP)
Every FHA loan requires Mortgage Insurance Premiums (MIP) regardless of the down payment amount or loan to value. In addition, FHA loans require Up-front Mortgage Insurance Premiums (UFMIP). The UFMIP can be financed into the loan.
Up-front Mortgage Insurance Premium (UFMIP)
UFMIP is calculated at 1.50% of the base loan amount on all loans, regardless of the down payment amount. This insurance protects the lender against losses in the event that the borrower defaults on the loan.
**The entire amount of the UFMIP can be financed into the loan amount!**
If the FHA loan amount is $100,000 (base loan amount)
The mortgage insurance premium would be $1,500 ($100,000 x 1.50%)
The mortgage amount including MIP would be $101,500 ($100,000 + $1,500)
What really happens during an FHA mortgage transaction is that the borrower owes FHA a lump sum mortgage insurance premium. The lender making the FHA loan will actually lend the money for the premium to the borrower and send the money to FHA so that the mortgage will be insured.
Monthly Mortgage Insurance Premium
In addition to the UFMIP, there may be a monthly premium due as well. The monthly premium is .50% of the base loan amount.
On a 30 year fixed loan, the monthly payment would be calculated as follows:
$100,000 x .50% = $500.00 / 12 months = $41.67 per month
Maximum Loan Amount
FHA also has maximum loan amount restrictions that differ from county to county. Go to entp.hud.gov/idapp/html/hicostlook.cfm to view the maximum loan amount in your area.
There are two types of conventional loans: conforming and jumbo.
A conforming loan requires a loan amount of $417,000 or less. Conforming loans offer a larger variety of loan programs than FHA with a wide array of lending options. A conforming loan generally requires a larger down payment for a purchase (usually at least 5%) and has more restrictive guidelines on getting cash out of the property for a refinance.
The big advantage of conforming loans is that they do not require Private Mortgage Insurance (PMI) if the loan amount of the new first mortgage is 80% or less of the value of the home. The elimination of PMI can offer a significant savings over the life of the loan.
Additionally, conforming loans offer interest only options. FHA currently does not allow interest only payments.
The Economic Stimulus Act of 2008 temporarily expanded the conforming loan limits through 12/31/2008 to as high as $729,750 in an attempt to shore up the slumping housing market. The new conforming loan limits are based on 125% of a city’s median home price. Go to entp.hud.gov/idapp/html/hicostlook.cfm to find the temporary conforming loan limit in your area.
A jumbo loan is any loan amount over $417,000. Jumbo loans generally have slightly tighter lending standards and may require an additional down payment of at least 10% of the purchase price. Jumbo loan programs are as diverse as conforming loan programs and also do not require PMI if the loan amount is less than 80% of the value of the home.
So, to summarize, it is really all about loan-to-value. If you plan on putting down a small down payment, than an FHA loan is most likely your best bet. But, if you are putting down a larger down payment, a conventional loan may be the way to go.