Buying a house with 5% down: FHA vs. Conventional with 95% LTV?

August 26, 2009 1:58 PM

House Mortgage-filter: FHA vs. Conventional 95% (LTV) Mortgage? Found a calculator, but it's limited and we're seeking hive mind wisdom instead.

We (me an Aunt Zeb) and several friends are separately considering buying homes in the California Bay Area, but we all need help deciding between a FHA mortgage and a conventional mortgage with 95% Loan to value (LTV). We've used the calculator, but it won't allow calculations for houses over $249,900. Our friends are looking in the range of $300k-400k houses.

Using some the following numbers as assumptions, please help compare the Conventional 95% LTV vs. the FHA mortgage:

House price: $350,000
Down-payment: $17,500 (5%)

Interest rate: 5.250% conventional vs. 5.375% FHA

FHA funding fee: 1.75% of the loan amount, can be financed ($6125) onto the mortgage. No such fee for a conventional loan.

Insurance:
FHA 0.5 - 0.55% / month (~$150) (FHA insurance cost) - required for 5 years.
vs.
0.9 - 1.9%/month (~$210) (private mortgage insurance) - may be terminated after 1-2 years.

Initial equity: +$XXXX(?) for the conventional loan?

Big question: Which is the right loan for us / our friends in that hypothetical scenario?

It seems the difference would be a slightly higher monthly payment for a conventional loan while paying PMI (about 2 years), then it would be less than the FHA loan monthly cost. After 5 years of the FHA insurance the two would be about even with a slight edge for the conventional loan. So, assuming they plan to own the house for 10+ years, which is the right loan for them? Are we missing anything that will have an impact on these figures

(Side question: I've heard an FHA loan may be "transferable" if the house is later sold to an FHA loan qualifying buyer ... can someone explain? And why/if this is not an option for a seller holding a conventional loan?)

posted by unclezeb to work & money (7 comments total)

Can you even get a conventional loan with a 95% LTV ratio? I thought lenders were requiring 20% down these days, so you may be stuck with FHA.
posted by willnot at 2:18 PM on August 26

The buyer would be on the hook for PMI until they have 75% LTV after 2 years (80% after 5 years), which could be a while. FHA requires 78% LTV or better before cancellation of PMI.

When looking at these numbers always adjust for the after-tax figures since interest and PMI are deductible at your top marginal rate.
posted by @troy at 2:27 PM on August 26 [2 favorites]

I would be shocked if the conventional loan at 95% were even available to you. My fiancée and I were laughed out of a couple of banks earlier in the year when we were considering it, and that's with FICO scores up near 800 and a crazy-low DTI. The liquidity situation for a lot of major lenders has only gotten worse since then. Major metropolitan areas are getting to the point where conventional lenders won't talk to you with less than 20%.

Even if it looks, on paper, like you'd be able to save $20 a month with a conventional loan rather than FHA, trust me when I tell you that the nightmare that awaits you is a lot more than $20/month's worth--even if you manage to find someone who is theoretically willing to underwrite your 95% mortgage, sellers won't take offers with more than 90% financing seriously, and your chances of having the mortgage collapse as you near closing are really uncomfortably high.
posted by Mayor West at 4:50 AM on August 27

Thanks for the fast replies!

(1) Two of the couples involved have been offered a 95% LTV conventional loan from reputable lenders. They have excellent credit (760+) and reasonable income relative to the house prices (i.e., couple makes $120,000/year looking to buy a $350,000 house). But it's still not clear if this conventional (or Fannie Mae) loan would be better than the FHA loan ... you start with more equity (no FHA funding fee) and may be able to stop PMI payments sooner (though they'll be higher than monthly FHA insurance fees) ... still don't know which would be better.

@Mayor West: as for having offers rejected with 95% financing, I hear you but some houses are not eligible for FHA loans, i.e., those which have not "seasoned" for 90 days so it may be as common to have FHA funding rejected as to have 95% LTV conventional loan offers rejected. I guess that comes down to individual houses and sellers, for now we're just trying to figure out if there's a reason to, generically, try for one type of loan or another assuming both are available and not a problem for the seller or any particular rules.

(2) @@troy: can you give us more details about how to adjust for after-tax figures? I'm not sure how much the difference between the two loan types would matter at tax time so any help or tips you have would be great so I can share with our friends!
posted by unclezeb at 6:09 AM on August 27

^ You should be doing this in a spreadsheet. . .

You can get complicated and adjust for state & federal tax breaks or keep it simpler and just calculate the federal tax break.

Income in the $65K to ~$131K bracket is taxed 25% at the federal level (for married filing joint), so since every dollar you pay in mortgage interest, PMI, and property taxes can be deducted against your earnings it's like you get back 25% of those payments, as long as you make over $65K.

So multiply all those costs by 0.75 to find their true out-of-pocket costs.

This won't really affect the FHA vs. bank calculation but it is one factor that should be accounted for in your decision since it is a rather massive benefit especially in the first 10 years of the loan when interest costs are high.
posted by @troy at 6:43 PM on August 27

The conventional loan is the way to go if you're comfortable with the higher monthly payment that you'll get because of the difference in monthly PMI. This helps you avoid the FHA funding fee (also referred to as the up-front mortgage insurance premium...or UFMIP) and allows you, as you said, to drop PMI once you have at least 20% equity in the home.

One benefit of going the FHA route: You're allowed to squeeze 6% seller concessions from the seller to put toward closing costs, escrow/impound, and any interest rate buydowns. The conventional mortgage only allows 3% (although that number may vary based on your lender).
posted by st starseed at 10:29 PM on August 27

Working on a spreadsheet for our friends - basing it off a good faith estimate spreadsheet with an extra column to contrast FHA and conventional costs/fees.

The answer seems to be "it depends" on many things. Fine answer now that I have an idea of what those things are and how to start guessing, estimating, and filling in where we/they can.

Any other tips or thoughts greatly appreciated!
posted by unclezeb at 2:54 PM on August 31