FHA Loans allow more consumers to own homes – they’re available to borrowers with credit scores even lower than 580 and with a down payment of as little as 3.5%. In addition, they’ll allow that down payment to be a gift from mom and dad.

But… they come with a cost.

FHA (The Federal Housing Administration) insures FHA loans – giving the lender protection should the borrower default. In exchange, borrowers must pay the insurance premium.

This is not unlike the insurance you buy for your automobile. If you wreck the car, your insurance will provide the money to pay off your loan. The difference is that you’re paying for the lender’s insurance policy. You’ll need homeowners insurance to protect yourself against “wrecking the house.”

FHA requires this insurance on all loans, regardless of the down payment. As of today the upfront premium is 2.25% of the loan amount and you will pay a monthly premium of .55% as well. These rates are subject to change as the debate goes on about how to “fix” the housing crisis.

By contrast, a conventional loan requires no Private Mortgage Insurance if your down payment is at least 20% of the purchase price (or appraised value if a refinance.) When you pay less than 20% down, your premium will be based on your credit scores, the loan- to- value ratio, and your debt-to-income ratio.

Regardless of credit scores or down payments, FHA requires that borrowers carry their mortgage insurance for 5 years. After this they can petition to have it removed if the loan-to-value ratio is under 78% and all payments have been made on time.

A conventional loan’s Private Mortgage Insurance can be eliminated after just two years of on-time payments.

Another difference: FHA loans are for primary residences only while conventional loans also cover investment properties.

Conventional loans require a minimum of 5% down payment, and this must be your own money – not a gift. They also require higher credit scores, with the minimum score of 660 resulting in a higher mortgage interest rate than a score above 740. In fact, the rate you pay will depend upon where your credit score falls in the range from high to low.

FHA guidelines allow for loans at 3.5% down with a credit score of 580 or higher. Below 580 the down payment is 10%. However, consumers should note that even with FHA mortgage insurance, few banks are willing to loan to an individual with credit scores under 620.

Author: Mike Clover

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