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Conventional versus government mortgages

By Trulia | Published: Oct 14, 2009 | 37 Comments

It is the most feared phrase in the English language, Ronald Reagan famously said:

"We're from the government, and we're here to help."

If government aid is evil, there are certainly some exceptions. Home mortgages insured by the Federal Housing Administration have helped put more than 34 million Americans into their own homes since the since the 1930s. Millions more have benefited from zero-down VA loans from the U.S. Department of Veterans Affairs and from the Department of Agricultures Rural Development loans. Mortgage guarantees and down payment assistance are also doled out by municipalities and state programs such as California's Housing Finance Agency.

It's hard to generalize about their pros and cons with so many government-enabled loans out there. But when we compare them to conventional (non-government) loans, a few observations arise.

FHA loans normally demand higher interest rates than conventional mortgages because of the increased risk of default. The "spread" between FHA and conventional loans can be as high as a point, or 1 percent, which is a lot. Borrow $200,000 for 30 years at 5 percent fixed and you'll pay $1,073 monthly. Make it 6 percent and you'll pay $1,199. It's an extra $45,360 over 30 years.

Why have so many buyers chosen FHA loans? Not because they like higher interest. It's about lower down payments. An FHA-backed loan today can be had for about 3% percent down, even by someone without stellar credit. The same borrower might be asked for 20 percent down by a lender without the FHA guarantee.

But there are complicating factors. FHA borrowers must pay an upfront fee of 1.5 percent of the loan amount, plus an annual insurance premium of 0.5 percent. That premium is about the same as what's paid by a conventional borrower who must carry Private Mortgage Insurance (PMI).

A higher-interest-rate FHA mortgage may cost less in the long run than a conventional mortgage with PMI, but there is no overarching rule. You have to run the numbers and compare. For many borrowers, the deal "maker" or "breaker" won't be the interest rates or monthly payments. For many, with conventional lenders now demanding 10 or 20 percent down, it's all about down payments.

In theory, it's possible to avoid PMI with a piggyback mortgage structure - by borrowing 80 percent of the property value in one loan and 10 percent on a second for example. (This trick was common in the loose-lending days of old but today (in 2009), it's much harder to find second-position lenders at loan-to-value ratios like these.

Two other brands of government-guaranteed loans are offered by federal agencies. The Department of Veterans Affairs will insure zero-down, 100 percent financing as a benefit to military veterans (even if they served in peacetime). The interest rates are similar to FHA loans.

Zero-down financing is also backed by the U.S. Department of Agriculture under its Rural Development program. The audience for RD loans is limited. They're intended to help low-income people buy, build or renovate homes in rural areas. Houses must be modest in size, design and cost, according to the agency. The interest rates are similar to FHA and VA loans, combined with 100 percent financing. Great terms for the needs of many people if they qualify.

Comments

By Jennifer Ready,  Fri Nov 6 2009, 07:26
you need 3.5% down for FHA not 3%. It was 3% up until January 1st 2009 then it switched to 3.5%. FHA rates are not generally 1% higher. In reality they are at most .25% higher. The interest rates being quoted may seem higher because a lot of brokers charge more to do FHA because they consider them more work. There are also a lot of lenders who do not pillage their FHA clients. I am assuming this is not written by a lender feel free to call me to see rate sheets etc..:)
By Jay Sondhi,  Fri Nov 6 2009, 17:21
Very true. The up-front mortgage insurance factor is also incorrect. It's 1.75%, not 1.50%. I have actually seen jumbo FHA loans with lower rates than conventional jumbos at times. There are many reasons that I believe the FHA option is superior to conventional. Running the numbers is key.
By Steve Kappre,  Wed Nov 25 2009, 21:29
It is true - often conventional and FHA rates are very close, with conventional typically edging out a little (.25% or so). But you know it all depends on where investors are putting their $$. We've all seen FHA rates lower than conventional at times. Also MIP as mentioned is usually 1.75% and monthly at .55%.

FHA wins hands down with less than perfect credit - and the PMI companies can make certain of that these days!
By Javier Meneses,  Tue Jan 5 2010, 07:14
Think they should get an actual mortgage professional to write or proof some of these......
By John Burke,  Thu Jan 7 2010, 14:24
All things considered, when you compare FHA vs Conventional for the average borrower, FHA wins hands down. When you look at all of the various conventional hits and add in the PMI costs and issues, it just really doesn't make sense for borrowers unless they have 10%+ down and 740+ credit scores. IMHO
By Samuel & Lora McElhaney,  Tue Jan 12 2010, 12:08
What ever allows you to drive the car up your own driveway, go for its far better to own your home than to rent it.But just be ready for all the responsility and of course choose the right home whichever morgtage you`ll be there a lifetime perhaps!!!!
By D,  Sun Feb 21 2010, 10:57
a little update since the first posts.... FHA has now decreased seller contributions toward closing costs from 6%, of the purchase price, to 3%. They have also increased their up front fee from 1.75%, of the loan amount, to 2.25%. Comparing FHA to conventional, FHA wins if you don't have good scores and down payment. Otherwise conventional typically is better. However, USDA stating they are targeting lower income... each county is different. Our county is small, USDA will allow zero down to an income of $74,300 even for a family size of 1. I don't think anyone would consider that low income. I think what Samuel says is correct, we shouldn't assume one program is better than the other. We are all different and what one program may be great for one, could be not so great for another.
By Home Buyer Help,  Fri Mar 12 2010, 08:11
Thanks for the great article! I love the comments to this post. So much insight in one place is nice to see. Thanks to all.
By Di Anne Warlick,  Thu Mar 18 2010, 10:43
The FHA UFMIP change is any new FHA case numbers assigned on or after April 5th. So you still have time to find a property and get your case number assigned to take advantage of the lower 1.75% UFMIP. The reduction in the seller's contribution has not gone into effect as of yet. FHA says it is coming early summer.
A USDA loan was referenced above and as of last week USDA announced they will be out of money to fund any new USDA loans by the end of April. They do not know when they will receive additional funds for that loan program.
I suggest going with a FHA loan over a USDA loan as of today. I would hate for someone to get all the way through underwriting only to find out that USDA cannot issue a loan commitment because they are out of funds.
There are several types of FHA loan programs available including the $100 down payment program and a 203k rehab loan program. If you find the right house you can combine both of those loan programs on one purchase - get into the house for $100 down , have the seller to pay for most of your closing costs and get some extra funds to do repairs on the home you are purchasing. Sounds like a deal to me!
By Robin Silverberg,  Sun Sep 26 2010, 07:49
New changes are coming to FHA on October 1st, so I think that Trulia needs to get someone to ammend the original posting about FHA. As everyone has said above, there is a minimal spread, if any at all, between FHA and conventional, not to mention the change in money down. The biggest change since this article was written is that because of the Fannie Mae/Freddie Mac overlays, the rate on a conventional loan can actually be higher than on FHA. The loan amount can make a difference as well, smaller loan amounts on FHA might warrant someone increasing the rate to justify what they would make on the loan. On a larger loan amount, that may not be the case. It is up to the loan officer usually to decide on what rate to give the borrower.
On October 1st, the up-front MIP fee on FHA is going down to 1%, however the monthly MIP fee is going to increase. I have not seen anyone yet who has put out a chart to show what the up-front will be on each LTV. If it is all the same, the factor is .90, if it depends on LTV, we may see that at lower LTV's, the factor is much less. If you are on the verge of either refinancing or purchasing, get your FHA case number now to avoid these changes.
By Camucha,  Sun Jan 9 2011, 13:28
I'would be great if anyone do the comparison between FHA and Conventional but in numbers so people can learn from your knowledge and make a wiser decision.For instance just said 100K [FHA+ 1.5% added to the amount borrowed + 3.5% =+interest {?} + insurance. [how much payments would be?
Do the same with conventional loans so We can see it in paper.
By MARCO HAUMAN,  Fri Apr 1 2011, 12:57
It depends all, on what your especifi circumstances are!!! There is not a general rule, as to what is the "best mortgage"...
By Debbie Hemphill,  Fri Apr 15 2011, 13:10
Hi Carmucha, on a FHA loan, you will need 3.5% down payment, and 3% for closing costs. So, on a $100,000 home, you subtract $3,500 down payment.
Your loan amount will be $96,500. The interest rate will determne your payment amount. Example: 5% for 30 years would be approx $523.40. 5.5% for 30 years would be approx $553.59. 6% for 30 years would be approx 584.56 per month. Plus you would add on taxes, insurance and PMI. So, depending on the home you buy, the payments with taxes, insurance and PMI, would add to your monthly payments. Ex: 1200 a year on tases would be $100. per month. 600 a year for insurance would add another $50.00 per month. And PMI of approx $55.00 would make your total payment at 5% interest rate approx. $728.40 per month Does this make since for you?

Conventional is the same, just subtract your down payment of 20% or more. Your loan amount will then be $80,000 versus $96,500. And your payment will reflect the differnce, but the taxes and insurance will remain the same, using my prediction of $100 per month for insurance and $50 per month for insurance. You will not have to pay PMI, due to the 20% down payment. So at 5% interest your payment will be $429.45 + 100+50 for approx $728.40. Hope this helps you!!
By Esme,  Thu Jul 21 2011, 12:07
All these coments help very much. Thank you! I currently own a condo that has lost its value. The loan amount is for 160,000 me and my husband are FHA insured. We were told that we cant buy another FHA property until we get rid of the current property or to get a conventional loan. We r medium income and we can't afford a 20,000 for downpayment, it would take years. Now, we cant sell because we will have to pay the difference of 80,000. I love my home but its a one bedroom. Does this mean we are stuck? There is no other way of getting another loan?
By Voices Member,  Mon Aug 15 2011, 18:20
Yeah this article really needs updating. This contains info that has been changed a number of times since posting. The context and intent is certainly right on, though. And remember, if you're looking at a home you wish to occupy and want to update/improve/renovate in almost any way including brand new appliances be sure to ask about the FHA 203(k) renovation loan for approved buyers! The 203(k) is a true heaven sent!
By Vee,  Sun Sep 11 2011, 14:27
If there are any professionals from Philly here, please call or email me. I'm looking to buy. I think the FHA may be that way to GO since I need non -traditional funding. Thanks for the info!
By Aram Arakelyan,  Wed Sep 14 2011, 13:44
When compared FHA vs Conventional for the average borrower, FHA wins hands down.

Aram Arakelyan
Your LA Broker for Life!
http://www.housevaluecheck.com
By Brad Cecil,  Mon Sep 19 2011, 06:13
You didn't even get the quote right in the lead. Furthermore, overselling home ownership and making it too easy to borrow money are partly to blame for the downfall of the country. It's amazing that with so much information available there can still be so much ignorance, or is it just dishonesty?
By Rentthouse,  Tue Sep 20 2011, 17:18
500
By Senior Citizen,  Sun Oct 2 2011, 08:19
My home is on the market and I received an offer from someone with an FHA loan. As the seller, I would have to pay 3% of their purchase price and they would pay for the inspection only. They are not required to put any money down and my 3% covers their closing costs.

I am disgusted. If they don't have money for a down payment, how are they going to maintain the home...pool, decks, huge lawn, ornamental trees and shrubs?

They'll let the place go downhill, eventually sell something that will need lots of TLC and sell at a lesser price than they paid. The neighborhood will suffer more loss.

The government continues to cripple the market.

We have neighbors who have a true financial stake in their homes. They continually work to improve their property and maintain curb appeal. But, they can't refinance because the mortgage meltdown caused by allowing 'the no money down purchase' has brought their home values to two thirds what they were prior to 2008.

I won't sell to anyone with an FHA loan.
By Judgenot..,  Fri Oct 7 2011, 01:03
To Senior Citizen, you sound very harsh and judgemental. I am middle aged, single with a child who has been unable to work due to serious health problems. I have enough income to pay a monthly mortage but I don't have enough for a large loan so the FHA loan may be the one way I can own my own home. If you are well-off financially, then good for you but don't assume everybody else is in your shoes and don't blame them f or it. I had a promising career until I lost my health. That is hard enough to deal with, then to read posts such as those you made is disgraceful. Try to imagine yourself in another's shoes.
By Judgenot..,  Fri Oct 7 2011, 01:04
By the way with your attitude you do not deserve to sell your home.
By Edward W Zukowitz,  Wed Oct 19 2011, 21:19
To the Proffesionals ............... Fha loan partnered with a 203k........ Whats that all about and i saw it mentioned above about the 6% closing cost needed for Fha. Okay , just too cut to chase. A condo 170,000, with $200/ monthly association fee, $2000 annual yrly taxes. What would i be looking at with upfront money and a round about for the monthly mortgage payments ????? I thank you for all your previous answered questions i have put out there. You are all a great help. Thank you again !!!!
By Enrique Navarro,  Sat Oct 22 2011, 15:14
Is it possible to get a loan with just a Taxpayer Identification Number or ITIN?
By Alanna Kirsten,  Tue Nov 1 2011, 23:39
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By Lady Luck,  Sun Nov 6 2011, 14:29
I would like to inform everyone that this house was built in 1874 by Mr Lawler and Mr. Palmer. It used to be Kathleens nursing home until a fire took part of it down, This house is one of two original homes left in town, I have proofd of the age
By Apprentice,  Sun Nov 27 2011, 19:13
Senior is correct if you cant save the money to buy a house how will you save money while buying the house to do any unexpexted repairs and PMI and the rest is just taking more money from someone who has no idea how to save, or some excuse why they cant save
By Olga,  Mon Feb 27 2012, 08:03
I am a Real Estate Aget trying very hard to find a property for a client that has an FHA loan. Nobody wants to sale to this person. The agents are telling me that the HOA do not permit these types of loans. It is unbelievable.
By Dyke-m,  Fri Apr 6 2012, 10:22
Am I the only military veteran here? I'm a service-connected 100% permanently disabled Vietnam era veteran. I lived in San Francisco for 30+ years in a very rent controlled, very undervalued 2 bedroom flat. As a result the "buy or rent" formulas always equaled "rent" for me until my landlord generously incentivized my giving up my tenancy about 3 years ago. The plan was to use my VA Loan Guarantee and buy my first house in mid-life and then the market collapsed. I have been waiting nearly 3 years in a much smaller apartment waiting for the market to settle. And NOW given the low interests rate and the deeply discounted home values near Travis AFB (I have Commissary and PX and other base privileges which makes my income worth much more) I am ready and it's time for me to buy. It's my first home: my paperwork is in order, I am B of A pre qualified, I have excellent credit scores, and savings (some in long term CDs but the rest I prefer to keep liquid for the move and unforeseen contingencies).

Unfortunately, my broker is saying that the VA Loan benefit will not be OK in a short sale which is "as is" making me completely uncompetitive in bargains which need any TLC. Most REOs are in better shape and tend to be better potentials but I also have to ignore any house with a wood deck attached ot the house. I assume this is all true but the VA website doesn't mention it and is not very specific in its FAQs. So, I trust my broker as she was interviewed and recommended by a best friend (who is also a broker in the luxury property market here though well outside my range). I can more than afford the mortgage payments on most houses (with my non taxed disability benefits) I've seen but I have to ignore more than half of the bargains due to these VA criteria which I can't find written anywhere on the VA site or published regs.

Even more unfortunate than the VA website lacking in info is that every real estate website which discusses Government loans almost exclusively (including Trulia) talk a lot about FHA loans, etc. but barely mention the VA benefis criteriat, the issues of veterans (especially disabled ones whose income is generous yet "unearned"), the intricacies of VA Loan Guarantees, or even mention anything about "Cal Vet loans" - a CA benefit I'd never heard existed - though I hear they are slow to approve. It's already hard shopping from SF County an hour NE for these great houses in Upper Solano County (I also have some ambulatory problems related to my disabilities) but I can't seem to find anything specifically useful to using my VA Housing Loan benefit.

Can anyone aim me in a direction where a veteran can get more info? There are a LOT of us and as Iraq and Afghanistan draw down there will be a whole more of us looking to use this benefit or understand what a CalVet loan is ... where are we supposed to go to get an analysis from outside each government agency? Thanks in advance.
By Mandrel,  Mon Apr 9 2012, 22:16
How to get a loan approve if you work 1099 without two year of 1099.
Is it possible to get loan approve with 1099 with 20 present down. Is conventional loan is the way to go.
By Jradke61,  Thu Apr 12 2012, 19:20
I am in the beginning stages of obtaining a VA loan to pay off the house I bought on a land contract 5 years ago. I just got a copy of my DD 214 and sending it in with Form 26-1880 to get my COE. My credit union has a VA loan officer and I have an appt. the 20th. I'll be able to pay off the land contract and then some for no money down @ 4.2% with a credit score of 620 or better. My current pay off is 82000 for a house that appraises in the mid to upper 90s. I've also made some major improvements since buying it and may have a bit more equity.
By Mrs. Ag,  Tue Sep 4 2012, 16:02
we are trying to buy a low priced home for my son in dayton ohio. He is disabled and was robbed. We currently have had this mrtg for 10 yrs we are retired and have a good income and only a 100 a month car payment, We pay cash and have 1 cc with 0 on it, We pay cash for everything making our credit score in the high 500's. We can;t find anyone that will give us a loan under 50,000. We only want to borrow about 25000. What do we do?If someone has an answer let me know...........wiilieman@aol.com I talked to a mrtg broker he said he couldn't help.
By Brandy,  Thu Sep 20 2012, 06:24
Have you tried a smaller lender such as one Reliable credit? They outdated in Salem even, idk just a thought
By stainz13,  Thu Oct 4 2012, 03:34
Senior Citizen is correct in a way but in today's market most people want to sell and get out from that horrible conundrum of waiting for the right buyer which may or may not ever come. Most people want to get on with their lives and unload their property and don't have the luxury of waiting for the right buyer to come along to maintain your property in the manner you did, so unfortunately for the neighbors they might have a less than stellar new addition to the neighborhood whether they have an FHA loan or not.
By Lee Gillette,  Fri Dec 21 2012, 09:58
Lots of good information here. I notice there is a lot talk about the numbers, which I agree is important to know and understand, but I would also like to point out that there are certain requirements that a subject property has meet in order to qualify for most government backed loans. Some of the aforementioned requirements don't apply across the board, but are important to pay attention to nonetheless.

I ran into a situation with a buyer using a USDA loan in which an issue regarding a shared well, ultimately killed the deal. Per the HUD requirements, which, to my knowledge, apply to USDA, VA, and FHA loans in some form or fashion, a shared well can service no more than four lots. In my case, the deed referenced a shared well agreement but did not specify how many lots shared said well. Upon further research, I discovered the well was used by well over 4 lots, therefore rendering the subject property unable to be purchased using a USDA loan.

In another situation, I was working with buyers who were planning to purchase a home with a VA loan. If you've ever worked on a VA loan, then I'm sure you are well aware they are not always a walk in the park. In this instance, the problem was not related to the VA requirements, but rather an inexperienced loan officer who did not have a good working knowledge of the VA loan process. If you ever work with clients who are planning to use a government backed loan, I strongly recommend that you advise your clients to seek the help of a mortgage broker/loan officer who has experience with these types of loans. You will save both you and your client a lot of time and energy that would other wise be wasted chasing a dream home that turns out to be nothing more than a nightmare.
By rocker10301,  Wed Apr 3 2013, 18:15
Thanks for all the info, it was good, now I need to know were to go for a FHA loan in Ga.
By Kobe,  Tue Aug 13 2013, 03:10
If you qualify for an FHA loan, your mortgage company may accept a smaller down payment. It may have a lower interest rate, but often a conventional mortgage is just as good. And besides that there are many lenders and some good banks (http://www.paydaybank.co.uk) for better assistance regarding mortgage loan.

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