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FHA vs Conventional
At first glance FHA rates look much better than conventional rates. However, these low rates are misleading.
The fact of the matter is that although FHA provides lower rates at the same or similar cost when compared to conventional financing, the mortgage insurance premiums are much higher for FHA financing, resulting in a higher payment on the FHA loan with similar cash to close requirements.
The following table illustrates why Conventional financing is a better option for borrowers with good to excellent credit scores putting less than 20% down in a purchase transaction.
As you can see, the FHA (column 1) loan has an interest rate of 3.25% that is lower than the conventional loan with Monthly PMI (column 2), and substantially than the PMI Eraser loan that totally eliminates the monthly PMI payment. The Cash to Close is similar for all three options. But take a look at the Monthly Mortgage Insurance line on all three options. The FHA loan has a monthly mortgage insurance payment of $187.97, about 50% more than the mortgage insurance payment on the conventional loan with monthly PMI. And the best option is the third column which has the highest rate of the three, but the lowest payment due to the fact that the monthly mortgage insurance is totally eliminated.
In the final analysis, either of the two conventional options will be a better option than the FHA loan for borrowers with very good credit. However, for applicants with median credit scores below 700, a case by case evaluation must be made to determine which is the better option. And for borrowers with credit scores below 620, the FHA loan may be the only available option since the conventional loan options will both require a minimum credit score of 620, and possibly higher.
For more information on mortgage insurance types and payment options and on avoiding PMI through the use of a “piggyback transaction” read our Guide on Mortgage Insurance.