Conventional and FHA loans — Part 3
In part 3 of our series, we will look closer at the subtle differences in mortgage insurance for conventional and FHA loans (remembering on an FHA loan it is called MIP = Mortgage Insurance Premium). First, let’s quickly recap some of the difference between private mortgage insurance (conventional) and mortgage insurance premium (FHA).
– There are ways to avoid mortgage insurance with a conventional loan. That is not the case on an FHA loan.
– There is an upfront fee of 1.5% of the loan amount for MIP on an FHA loan.
– The monthly premium for MIP (FHA) is less than the premium for PMI (Conventional)
– MIP is based on the purchase price of the home and not the appraisal value of the home.
So what is the difference basing mortgage insurance (MIP or PMI) on the purchase price versus the appraisal value of a home? The difference involves when you can remove the mortgage insurance payment from your mortgage. Let’s look at an example based on the following:
– the purchase price and appraisal value are both $200,000
– 78% loan to value will be used as the threshold needed to be met in order to remove mortgage insurance
– both loans will be 100% financing with an interest rate of 6.000%
If you purchase a $200,000 home with an FHA loan, MIP is based on the purchase price. In order to remove MIP, the loan must be paid down to $156,000, or 78% of the home’s purchase price. Making regular monthly payments, it will take 12.5 years to pay down the loan to 78% of the purchase price in order to remove MIP.
If you purchase a $200,000 home with a conventional loan, PMI is based on the appraisal value. You make your regular monthly payments, but let’s say over the course of 5 years, your home averaged an appreciation of 1.5% per year. After 5 years, your house is now worth almost $215,500. Instead of needing to pay down the loan amount to $156,000 to remove PMI, your new target is $168,090. If your home continued its 1.5% appreciation each year (and you continued to make your regular monthly payments), you would reach the 78% mark at year 8 – roughly 4 years earlier than on an FHA loan.
In summary, if you qualify for a conventional loan, odds are it would be better in the long run to get a conventional loan in order to avoid paying the 1.5% upfront MIP fee with FHA loans along with being able to remove mortgage insurance sooner with a conventional loan.
Borrowers who don’t qualify for a conventional or are in need of down payment assistance should take a closer look at FHA loans, but be careful! Some down payment assistance programs are not what they seem, and that will be part 4 in our series.
Clay Jeffreys is a Mortgage Consultant with Hillside Lending, LLC and writer for “Blog Pertaining to the Acquisition of a Mortgage to Purchase a Domicile.” Hillside Lending seeks to provide mortgage brokerage services with the highest standards of service, care, honesty, integrity and value; concentrating on owner-occupied, residential financing. For more information about available programs and interest rates, please visit www.hillsidelending.com.
