mortgage

Save by comparing FHA to PMI

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Highlights
  • With a down payment of less than 5 percent, FHA is an option and PMI isn't.
  • When FHA insurance and PMI are available, compare costs.
  • Some lenders might steer borrowers into FHA even if it costs more.

You may have heard that FHA loans can be a great mortgage option because they offer lower interest rates and are easier to qualify for.

But remember that easiest doesn't always equal cheaper or better.

FHA mortgages allow down payments as low as 3.5 percent and have less stringent underwriting guidelines than conventional loans because they are insured by the Federal Housing Administration.

But they come at a price that sometimes can be significantly higher than what you would get with a conventional loan.

"It seems like FHA is really close to a subprime loan," says Kristen Martinez, president of Assai Funding in La Quinta, Calif.

That doesn't mean FHA loans are bad and you should stay away from them, she says. They can be a great opportunity for many potential homebuyers, but you have to make an informed decision.

When an FHA may be the right option

If you don't have at least 5 percent for a down payment or if your credit score is not high enough to qualify for a conventional loan, an FHA loan may work for you.

For instance, a borrower with a 620 credit score may qualify for an FHA loan with 3.5 percent down payment, Martinez says. By contrast, to qualify for a conventional mortgage, a borrower generally needs a minimum credit score of 680 and at least 5 percent down. Many lenders require at least 10 percent down.

Unlike with conventional loans, FHA allows you to receive your down payment money as a gift from a relative. In conventional loans, you must demonstrate that at least 5 percent came from your own savings.

Those who went through bankruptcy or foreclosure recently may also be able to benefit from an FHA loan, says Jack Guttentag, a professor finance emeritus at the Wharton School of the University of Pennsylvania. If two years have passed since your bankruptcy or foreclosure, you may qualify for an FHA loan. With conventional loans, you have to wait five years before you can qualify, he says.

When FHA is not for you

In general, if you qualify for a conventional mortgage and have the sufficient required down payment, you should stick to the conventional loan.

If you can put 20 percent down on a home and have a credit score above 720, there is no question that an FHA loan would be the wrong choice, says Matt Hackett, underwriting manager at Equity Now in New York City.

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Cost comparison

The rule of thumb to decide whether an FHA loan is your best option is simple: Ask for a comparison, says Michael Moskowitz, president of Equity Now.

Your mortgage broker or loan officer should be able to give you a detailed comparison of an FHA loan versus a conventional loan, including upfront fees, mortgage insurance costs and monthly payment estimates.

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