Understanding Conventional & Government Mortgage Products & The Choices Involved
Understanding Conventional & Government Mortgage Products & The Choices Involved
The mortgage industry, and its terms, can be extremely confusing. Understanding mortgage products is important before entering into a purchase transaction. Things are slightly different for refinance loans which will not be covered here. In general, the terms of a mortgage (rate, mortgage insurance and fees) can change dramatically based upon your fico scores and down payment. The difference between costs in government and conventional loans is also quite different. Both of these programs are subject to conforming and government loan limits, so you will have to look up conforming loan limits for your county. In most counties in California the conforming loan limit is $725,000 but much higher in coastal areas. FHA limits are lower. If you are looking for no down payment loans, please go to my blog, “The Best No Down Payment Loans on the Market.” These loans have higher rates and terms than regular loans with down payments.
When shopping for rates and programs, this can also be quite confusing if not explained. For example, on the face of it, FHA interest rates are generally much lower than conventional rates, as much as .75% in rate. But FHA requires a much higher mortgage insurance premium both monthly and up front and is also much more expensive cost wise. FHA mortgage insurance premiums are two-fold. For down payments less than 10% down, the mortgage insurance factor is .85% of the loan amount charged annually and divided by 12 months.
RECENT UPDATE: FHA has recently lowered its monthly mortgage insurance from .85% to .55%, making it much more comparable to conventional loans. For example, if the loan amount is $300,000 then the formula is $300,000 x .85% = $2550 divided by 12 = $212.50 a month. Additionally, the loan amount is charged 1.75% in additional mortgage insurance and financed into the mortgage. For example, a $300,000 loan amount is charged 1.75% ($5250) and added to the loan amount ($305,250). Both of these factors raise your payments. If you put 10% down or more, the monthly mortgage insurance is lowered to .80% monthly. If you take a 15 year loan, the monthly insurance is only .70% of the loan amount with less then 10% down and .45% with more than 10% down.
VA (government loan) offer a tempting no down payment product and there is no mortgage insurance but there is a hefty funding fee for no down payments. The funding fee is paid at close. For first time use, it is a whopping 2.3% of the loan amount and 3.3% for subsequent use. If one puts 5% down the fee is reduced to 1.65% and for 10% down, 1.4%, financed into the moprtgage. VA rates, a government loan, are usually better than conventional rates, but if you are putting 10% down or more, you will be better off getting a conventional loan.
Perhaps USDA (government loan and technically part of the FHA family) is the cheapest product for less than 3% down products. With this product, you can only buy in a rural area, recognized by USDA with no down payment. The monthly mortgage insurance factor is .35%, very cheap but the up-front premium that is financed is 1% of the loan amount. Still this is a bargain for a no down product.
Conventional products offer as low as 3% down and there is no upfront mortgage insurance but monthly premiums are much lower than FHA, about .25% as compared to FHA’s .55%. (If the loan amount is $250,000 then times that by .25% ($625) divided by 12 = $52.08 a month. If your credit scores are 720 or better this is the way to go. On the other hand, if your credit scores are less than 680, You should go FHA as the rate with this low of a down payment sky rocket on conventional loans. To avoid mortgage insurance on conventional loans, you have to put 20% down. Some lenders will subsidize the mortgage insurance with a higher rate. I wouldn’t do that. It is more expensive.
All of these products are for owner occupied loans. Minimum down for second or vacation homes is 10% down and rates and fees are very high for these loans. Minimum down for rental properties is 20% down.
You will have at least a 2 year job history, good income and credit for these products unless you are going FHA, you can have a credit score of 580.
The more you put down on a conventional loan the lower the mortgage insurance premium. No matter how much you put down on a FHA loan there is always a mortgage insurance premium. With 10% it is reduced a little from .85% to .80%. (see update above) All of these loans allow for a co-signer to make up for income, but not for bad credit. if you have very bad credit, co-signers won’t help, less than 580 fico scores.
If you are putting 3% down, you can only buy a single family residence with a conventional loan. If you are buying FHA, you can buy 4 units with 3.5% down.
Summary:
With the recent FHA change in mortgage insurance, you will be better off with a FHA loan over conventional, especially if your credit scores are over under 680 with the minimum down. If your scores are over 760, it is close but FHA will have a much better rate overal; and even though you are paying more in costs for FHA, it is being financed rather than being paid out of pocket.
Ralph Migliozzi
Broker Originator Serving Northern California
NMLS 282851 DRE #01002038
(p) 530-330-3073
