Conventional 97 (3.0% Down) or FHA (3.5% Down) – Which is Better?
If a low down payment mortgage is your preference, there are two programs that might suit your needs. The Conventional 97, a Fannie Mae product, and the FHA loan. They’re both very similar and even more so beyond the low down payment. If you’re eligible for both programs, there are some questions to ask to determine which works better for you. I can do this over the phone with you with just a few questions.
How to Qualify
One of the main considerations is going to be your qualifying credit score. You’ll want to complete my online loan application as well as authorize me to pull a credit report and credit scores.
There will be three credit scores reported, one each from the three main credit repositories of Experian, Equifax and TransUnion. The three-digit scores range from 300 to 850 and of the three reported scores, we’ll throw out the highest and lowest of the three and use the middle score for qualifying. When looking at the Conventional 97 and FHA options, the score impacts which direction we’ll take.
FHA loans are more forgiving as it relates to credit and credit scores in general. For an FHA loan, your qualifying score needs to be 580 or better. But with a Conventional 97 loan, the minimum score is 620 and some investors ask for an even higher score. Further, with a Conventional 97 loan, available rates actually improve the higher the qualifying credit score actually is.
Both the FHA and Conventional 97 require mortgage insurance policies. These policies are indeed insurance and compensates the lender for the loss should the loan ever go into default. The FHA loan has two such policies, an upfront policy and an annual one that is paid in monthly installments. FHA mortgage insurance premiums do not change based upon a credit score but with a Conventional 97 they can. The better the score, the lower the premium for the 97 option. With an FHA loan, the premiums are the same regardless of the qualifying score.
Interest rates for an FHA loan do not change as credit scores are higher or lower but with the 97 option they can. If someone has relatively low scores, something approaching the FHA minimum of 580, the FHA loan is likely going to be the better option because the rates for the Conventional 97 will be higher with a 620 score compare to an FHA loan with a 580 score. Conversely, for someone with excellent credit, say something like 720 or higher, the Conventional 97 will likely work out to be the better choice.
Further, mortgage insurance premiums remain over the life of the loan. The upfront FHA premium is rolled into your loan, but the annual premium is paid by you each month. The monthly payment is based upon the prevailing premium and the outstanding loan balance. As the loan balance is paid down, this monthly mortgage insurance premium installment payment also goes down.
Conventional 97 Loan
With a Conventional 97 loan, there is no upfront fee for mortgage insurance. And, just like most any other conventional loan, once the mortgage balance is paid down to 80% of the current value or naturally amortizes down to 78% of the original value, this private mortgage insurance payment goes away.
This is also important as it relates to how long you plan on keeping the property. If you anticipate keeping the home for a long time, say 5 to 10 years or more, the Conventional 97 is the better option because conventional mortgage insurance can be canceled later when the loan is paid down to the 80% level. For someone thinking a shorter term than say 5 years, then the FHA might be preferable.
The Conventional 97 is also reserved for first-time buyers. A first-time buyer is defined as someone who has not owned a home within the previous three years. FHA loans have no such first-time buyer requirement. Both however do require the borrowers occupy the property as the primary residence. Neither can be used for a rental property.
As it relates to closing costs for both loans, they will be very similar to one another if you factor out the upfront mortgage insurance premium for the FHA loan. While that’s a cost, it’s not an out-of-pocket cost. Beyond that however, you can expect standard closing costs for both lender and non-lender fees. Again, this is something I can help you with by providing an estimate of costs for both financing options. There will be differences, but not by a wide margin.