FHA vs. Conventional Loans

The FHA has been in the news a lot lately. More recently because of the pending conforming loan limit FHA Logochanges. Just a word on that, especially those of you in Michigan – don’t expect much if any change in our conforming loan limits.

The calculation is based on 1.25% of the median home values. Which means for Michigan homeowners our calculation will be based on a average value of $141,000 x 1.25% = $176,250. This is well under the current conforming limit of $417,000 and on top of that, we are not considered a high cost living area. So if you have a jumbo loan (loan amount greater than $417,000) I would not plan on refinancing for the sake of refinancing.

Why will FHA loans be the most used in 2008 by lenders who are working in the interest of their home buyer clients?

  1. Interest rates are consistently lower than conventional loans by 1/8% to 1/4%
  2. FHA Mortgage Insurance Premium rates are lower than conventional PMI rates with similar down payments and are tax deductible like interest.
  3. PMI is now deductible, if you itemize on your tax return (please consult a tax professional). This makes the effective cost of this loan in a lot of cases less than a comparable conventional loan.
  4. The minimum down payment is 3%. In some cases, subject to appraisal and seller approval) the seller can even gift this amount. Seller are still able to pay all of buyers’ closing costs usually around 3 or 4% (can pay up to 6%).
  5. Even though conventional loans can approve borrowers for $0 down based on underwriting, Fannie Mae is tagging many neighborhoods as declining value areas and requiring 5 to 10% down payment minimums for many borrowers. Some lenders are no longer doing $0 down loans at all in Michigan. Within the last week a few of our lenders no longer offering conventional 0% down loans the minimum down payment on purchases will be 10%.
  6. Credit scores are allowed to be less than conventional loans (often a 600 score is all that is needed to be approved).
  7. Loan limits are around $200,000 with no maximum income requirements.
  8. It is a great option for someone who has and ARM loan adjusting and has a stagnant appraised value. FHA is more easily able to combine first and second mortgages with fixed rates and reduce the total mortgage payment.
  9. FHA underwriting still allows for deferred student loans to be ignored in debt to income ratios for approvals.
  10. FHA loans are automated and documentation requirements are streamlined. Many agents who have in the past worked with higher sale priced homes, and have not dealt with FHA for a few years, you will be surprised at how much easier they are now.
  11. Can finance doublewide manufactured homes with little money down.

I have been in the lending business for almost 15 years. In the last 7 years, because conventional loans made lending possible for many more home buyers without the upfront PMI, my clients closed very few FHA loans. Since January 1, 2008, however, I have originated more than 15 FHA loans and will close most of those this quarter. I am excited about how easy, inexpensive to the borrower and flexible they are.

If like me, you have not used them, reconsider them for your home sales. If you have been using them consistently over the last few years, keep using them. They are becoming a first option for competitive lenders in serving their clients.

A couple of additional considerations:

  1. The home still needs to pass inspection – FHA will be more lenient on this in 2008 than before but it should still be considered. You will begin to see more FHA 203k (home improvement) loans offered. These loans do add expense and time to processing. Combining a construction loan program to a government loan program will be more cumbersome.
  2. FHA still charges an UFMIP (up front mortgage insurance premium). This is 1.5% of the loan amount ($2,250 on a $150,000 loan) and is added to the loan amount at closing. Remember, this can be refunded in part within seven years if the loan is paid off during that time. First time homebuyers will usually get some of this money back when they sell their home.

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