FHA Loan vs Conventional Loan - Which Loan Is Best?

which Loan program offers the best rate the best terms and the lowest monthly payment I'm often getting people reaching out to me asking me which Loan program is best for them and they're usually comparing conventional financing to FHA financing so what I want to do in today's video is break down the differences we're going to talk about the differences in credit score differences in down payment differences in debt to income ratio differences in mortgage insurance gift funds employment everything you need to know to decide which Loan program is best for you now understand in some scenarios FHA is going to be a better Loan program for you and in other scenarios conventional financing might be a better program for you but what we're going to do here is break them down and then we're going to give you some monthly payments we're actually going to break down FHA Loans versus conventional loans with two different credit scores to show you which Loan program offers the best rate the best terms and the lowest monthly payment now before we dive into that I'd like to take a minute and ask a favor if you find any value in my videos at all do me a favor and hit that thumbs up it helps the YouTube algorithm push it out to more people like you and if you like content like this do me a favor and hit that subscribe button now while there are some similarities between conventional financing and FHA financing there's also some big differences and one of the primary differences in the two loans is the credit score requirements FHA allows you to purchase a home with as low as a 500 credit score whereas conventional financing requires at least a 620 credit score now with that said if you're buying a home and you're using FHA and you have below a 580 credit score it's going to require a 10 down payment if you have above a 580 credit score it requires a three and a half percent down payment and that's also one of the big differences versus conventional financing conventional financing allows as little as a three percent down payment but once you go below a 680 credit score you're going to have to put at least five percent down out in order to get conventional financing to approve it now with all of that said I often have people reaching out to me saying hey Jeb I have a 500 credit score and I have the 10 down payment but the lender is telling me that I don't qualify understand that just because you meet some of the basic requirements in today's video doesn't necessarily mean the lender is going to approve you for the loan there are some additional requirements that we're going to talk about today with DTI being one of the big ones but there's also some other requirements with regards to employment with regards to income that you need to satisfy in order to get approved especially when you have some of these lower credit scores the lower your credit score and the lower your down payment the more difficult it's going to be to qualify in many cases is oftentimes it requires a lender to manually underwrite that loan and when lenders manually underwrite loans they go through the file with a fine-tooth comb so they're looking at everything versus in the cases when you get an automated approval it's more or less a slam dunk as long as you can satisfy the lenders conditions at that time so we've talked about the differences in credit score we've talked about the differences in down payment now I want to talk about the differences in debt to income now debt to income is one of those things that can be very difficult for a consumer to understand because of how it's calculated but your debt to income is basically just your debt versus your income which means they take up all of your expenses on your credit report things like your student loans things like your car payments things like your credit cards in addition to your proposed housing expenses how much your mortgage is going to be how much the property taxes are going to be how much your mortgage insurance your property insurance if there's a homeowners association they take all of those fees they add the debts that come from your credit report and then they take that total amount and they divide it by your gross monthly income which is your income before any taxes are taken out so in the case that you have a monthly mortgage payment with everything included at say 3 500 a month and let's say you have another five hundred dollars in monthly debt that shows up on your credit report well that's a total of four thousand dollars in debt well let's say that you make a hundred and twenty thousand dollars a year well that's ten thousand dollars a month so what they do is they take that four thousand they divide it by that ten thousand which says that your debt to income ratio is at forty percent which in the case of FHA and conventional you should qualify based on that debt to income ratio alone but one big difference is FHA is way more lenient is they allow you to go as high as a 57 back-end ratio whereas conventional financing you really have to stay under 50 which means that when using FHA you can actually qualify for more home with more debt using FHA than you can with conventional financing and that's a big reason that a lot of people go towards FHA is because it's a little bit more lenient because it allows lower credit scores as well as a lower down payment now with that there are some requirements that both loans have when it comes to mortgage insurance conventional financing is going to require mortgage insurance when you put less than 20 down so anytime you buy home with less than twenty percent down you're going to have mortgage insurance whereas in the case you're buying a home using FHA financing it's going to require mortgage insurance whether or not you put three and a half percent down you put five percent down 10 down 50 down there's going to be mortgage insurance on that loan now with that said if you put at least 10 percent down the mortgage insurance will fall off after year 11. but in the case that you put less than 10 percent down that mortgage insurance is going to be on it for the life of the loan now with that said there's a lot of people out there that are looking to buy homes that don't have 20 down but are also saying I don't want to use a loan program that's going to require mortgage insurance I want to avoid mortgage insurance therefore I'm going to continue saving until I have at least 20 down to buy a house and that's okay if that's your plan but don't get scared of mortgage insurance I personally believe there's a lot of misinformation out there about mortgage insurance that scared people away from buying homes because of mortgage insurance understand mortgage insurance is not a bad thing thing especially if you don't have the full down payment for 20 in fact I'm going to show you a couple of examples today comparing FHA to Conventional loans where the mortgage insurance is a little bit more expensive than say conventional financing but the monthly payment ends up being lower and so with that I feel like right now is a really good time to talk about effective interest rate effective interest rate is essentially your interest rate plus your mortgage insurance if you will so in the case that you get an FHA loan and the interest rate is six and a half percent and your mortgage insurance is point five five percent that means your effective interest rate is 7.05 so more or less just over seven percent but on the flip side if you get a conventional loan and the rate is seven and an eight percent seven point one two five percent then your effective rate is 7.125 or maybe in some cases of that conventional loan there's also mortgage insurance at point four five percent so in in the case that you have an interest rate it's a seven and eight percent you have to add that point four five on top of it so you're looking at an effective interest rate over 7.5 percent so when you're comparing conventional to FHA just make sure you're comparing the full effective rate and don't get scared of having mortgage insurance you can always refinance out of it at a later time at the end of the day most people aren't going to keep the same loan for a 30-year period of time to start with so if you get equity in your property you get to a time when you're looking to sell your property maybe you're looking to pull cash out or do something in the future you can refinance that loan and if you're in an FHA loan you can go to a conventional loan if you want to but either way your effective rate is your effective rate which means it's whatever your interest rate is plus the mortgage insurance on top of it so make sure you're using that when you're comparing the two loans now I know some of this can be difficult to understand when talking about effective rate when talking about comparing the two loans that's why it's always super super important to make sure sure you're working with a mortgage professional you're not watching my video going out and trying to calculate your own numbers or seeing if you qualify talk to a mortgage professional somebody that does this full-time someone that understands the stuff and can guide you in the right direction if you don't have that person I've taken the time to create a link below that will refer you to somebody I know like and trust that can guide you through that process and something to keep in mind it's completely free they'll give you a comparison comparing FHA to Conventional and ultimately help you decide which Loan program is right for you now on top of that FHA does have some other requirements if you're buying a condo FHA requires that that condo is FHA approved whereas conventional financing doesn't have that requirement so in some cases conventional financing can be better especially when you're looking at condos because it gives you more options on top of that another really nice thing about FHA financing is it also allows you to put that minimal down payment when financing units so if you're buying a three or four unit property you can get away with that minimal down payment of three and a half percent whereas when you're using conventional financing once you start to buy units it's going to require more money down now the last thing I want to talk about before comparing the monthly payments on these two different loans is that both loans require two years of consistent income and consistent employment now that doesn't mean you can't have gaps it doesn't mean you can't change jobs but it needs to be a consistent line of work and you need to have consistent income now with that FHA can actually be a little bit more strict when you have gaps if you have a gap on the job you need to have at least six months back on that job in many cases but this is another thing that you want to talk to a lender about because A lender can really go through the specifics of it check with an underwriter and give you an example based on your situation versus just a general statement in a YouTube video and one more thing both loans allow gift funds so if you're somebody that's getting a down payment has the ability to get a gift for a down payment both FHA and conventional financing allow that with no problem now earlier in the video I said I was going to compare to loans now what I want to do is compare FHA to conventional financing using real numbers in today's example we're going to be talking about a 350 000 purchase with credit scores at 780 and credit scores at 680 and we're going to look at a 10 down payment versus a five percent down payment so the very first example I want to talk about is a conventional loan putting five percent down putting 10 percent down with a 780 credit score now we're talking about buying a single family home which I know for many many people out there watching this video you can't buy a 350 000 home in your Market but this is just to give you a really good idea because if one Loan program is better than the other at 350 as you go up to 500 you go up to 750 you can see how much of a difference it will make in those loan programs so in the case of conventional financing based on today's rates you'd be looking at an interest rate of 7.125 which means if you're buying a 500 000 home putting five percent down that's 17 500 which means you're financing three hundred and thirty two thousand five hundred dollars which would give you a mortgage payment of two thousand two hundred and forty dollars a month now for property taxes we're going to be using one and a quarter percent now for some areas of the country that's going to be a high number and other areas of the country that's going to be a low number just make sure wherever you are you're using the tax rate for your area but based on one and a quarter percent you're looking at three hundred and sixty four dollars in monthly taxes on top of that you're going to have property insurance property insurance based on a calculation of point zero zero three five percent is going to give you eighty seven dollars and fifty cents per month the mortgage insurance is going to be based off using two borrowers the reason I'm saying this in this video is because two borrowers actually get a better mortgage insurance rate than one borrower so if you're a single borrower and you have a 780 credit score your mortgage insurance is actually going to be a little bit higher than what I'm quoting here but that number is going to be 0.23 which means your mortgage insurance is going to be just over 63 a month so all in and you're looking at a total mortgage payment of two thousand seven hundred and fifty five dollars putting five percent down using a conventional loan with a 780 credit score and the 10 calculations would be more or less the same thing the interest rate also be 7.125 but the mortgage insurance would actually be a little bit different it would be point one four percent which is a total of 36.75 making your total mortgage payment 2 611 per month now what I want to do is compare that to FHA but before I do that I want to compare it to Conventional with a 680 credit score because a 680 credit score isn't an awful credit score but you'll see how much that 100 Point difference in your credit score actually impacts your monthly payment when doing conventional financing so in the case of conventional financing putting five percent down your interest rate is going to be 7.875 percent so that's point seven five percent higher three quarters of a percent Higher by having a hundred points lower in your credit score which gives you a mortgage payment of two thousand four hundred and ten dollars per month property taxes are going to be the same at three hundred and sixty four dollars and property insurance is also going to be the same at just over eighty seven dollars whereas the monthly mortgage insurance is going to be higher at point six eight percent giving you a monthly mortgage insurance payment of a hundred and eighty eight dollars bringing your total mortgage payment to three thousand fifty one dollars per month that's 296 dollars higher than the borrower that had a 780 credit score so you can see how much that credit score impacts your monthly payment now I want to do the same thing for ten percent down at 10 the interest rates also going to be 7.875 bringing your mortgage payment to two thousand two hundred and eighty three dollars the property taxes are the same the property insurance is the same but your mortgage insurance is going to be point four six percent bringing that amount to a hundred and twenty dollars per month so giving you a total monthly mortgage payment of two thousand eight hundred and fifty six dollars which is 240 35 dollars higher than that borrower that had a 780 credit score now how does FHA compare to the two scenarios I just gave you well one nice thing about FHA in this case is that the interest rate is the same with a 780 credit score and a 680 credit score and in this example that interest rate is 6.5 so it's considerably better than the conventional financing now while FHA does allow a minimal down payment of three and a half percent in today's video we're doing a five percent down and a 10 down option just to compare it to conventional financing using the same number so in the case of the FHA loan putting five percent down you still have the same down payment of 17 500 but the biggest difference is FHA has upfront mortgage insurance of 1.75 which means they charge you 1.75 on top of your base loan amount in order to do FHA financing there's no way around this doesn't matter if you put five percent down or fifty percent down you have upfront mortgage insurance now it can be financed or it can be paid out of pocket most people just Finance it which means instead of having a base loan amount of 332 500 you're actually going to have a base loan amount of 338 319 that's because you're financing that five thousand eight hundred and nineteen dollar upfront mortgage insurance on top of your loan but here's the thing your interest rate is quite a bit better as we said earlier which means your monthly mortgage payment is going to be two thousand one hundred and thirty eight dollars and forty cents which is a hundred and two dollars less than the conventional loan the property taxes in this case are going to be the same at 364 dollars that the property insurance is going to be the same at eighty seven dollars but you are going to have monthly mortgage insurance in this case it's point five five percent which is 155 dollars and six cents now remember earlier when we talked about effective interest rate in this case the interest rate is six and a half percent the mortgage insurance is point five five percent which means your effective rate is 7 0.05 percent now remember with conventional financing same scenario the interest rate was 7.125 so in this case the effective interest rate with FHA is actually lower than conventional financing but all in gives you a total monthly mortgage payment of 2 745 a month which is ten dollars less than that of conventional financing not a huge difference in the 780 scenario but it's a huge difference when it comes to the 680 credit score is that's a 306 dollar difference in your monthly payment so in the case that you have a lower credit score in this case a 680 you're way better off using FHA financing than conventional financing but how does it look at 10 down now with 10 down your base loan amount before you add The Upfront mortgage insurance back is three hundred and fifteen thousand dollars but The Upfront mortgage insurance is five thousand five hundred and thirteen dollars so the amount that you're financing is actually 320 513 the interest rate is still the same it's six and a half percent which gives you a total monthly mortgage payment of 2 two thousand and twenty five dollars per month property taxes are the same property insurance is the same but in this case your monthly mortgage insurance is actually going to be a little bit less at point five percent bringing that monthly amount to a hundred and thirty three dollars which gives you a total monthly mortgage payment of two thousand six hundred and eleven dollars now when you compare that to the conventional financing with the 780 credit score it's basically the same the same monthly payment so in that case you might do conventional financing but in the case of the 680 credit score that is once again a 245 dollar difference in your monthly payment so for most people out there FHA would be the better loan when comparing it to conventional financing but like I said earlier in the video if you're out there shopping for a loan make sure you're having your lender run conventional numbers and FHA numbers and compare them side by side that way you can see both figures and decide for yourself which loan is the right program for you now often what I find is when people are watching this video they're usually first time home by buyers trying to figure out which Loan program is right for them trying to figure out which direction they should go and if that's you there's something I want to mention I created a first-time homebuyer course to guide you through this process really A to Z talking about everything from loan programs to writing an offer how to negotiate and the things you need to think about when buying a house so if you're interested in learning more about how to become an expert when buying a home do me a favor and check the link below now in order to make this video on the shorter side there are some things I left out when comparing FHA to Conventional so if you're one of those really detail-oriented people and you want all the information I've put it in both of these videos right here

Channel: Jeb Smith

Views: 30,411

Keywords: fha loan, fha loans, what is an fha loan, real estate, first time home buyer, home loan, how to buy a house, buying a house, housing market, real estate for beginners, fha loan requirements, fha loans for first time home buyers, how to get an fha loan, first time home buyers, california, huntington beach, first time home buyer loan, fha loan limits, housing market 2023, fha loan requirements 2023, fha 2023, fha loan 2023, fha vs conventional, conventional loan

Id: y20DwaOje6M

Length: 18min 39sec (1119 seconds)

Published: Fri Jul 14 2023