For over 80 years, first-time homebuyers have taken advantage of all the benefits of the FHA Loan, a mortgage product introduced by the Federal Housing Administration in the 1930s to increase home construction, reduce unemployment and help Americans realize the American dream of homeownership.
Because FHA loans are government-backed, they’re still an excellent option for a buyer with less money saved for a down payment or a lower credit score. But things are starting to change and buyers are beginning to look for home financing alternatives.
First-time buyer financing trends
According to NAR, the National Association of Realtors, fewer first-time homebuyers are financing their first homes with an FHA Loan. In fact, since the start of the pandemic, more first-time buyers have been choosing the conventional financing route.
Less than a decade ago, nearly half of all first-time homebuyers chose an FHA Loan. But according to NAR, the National Association of Realtors, fewer first-time homebuyers are obtaining FHA-insured mortgages — just 24% versus nearly 60% who are getting Conventional loans.
Why are conventional loans so popular all of a sudden?
Three reasons: More cash in the bank, more relaxed mortgage insurance and lower down-payment options than ever before.
First up: Pandemic savings
There was a lot of hardship during the pandemic and it’s still happening. But those who were able to keep their jobs, switch jobs or upgrade their positions may have been actually able to save money. That’s because more people worked from home, thereby eliminating the costly commute and reducing the need to upgrade their work-in-the-office wardrobe. They ate at home instead of dining out every night. And who even spent money having a social life over the past two years?
According to statista.com, the average savings rate in 2020 reached 17.2%, with a spike of 33.8% in April of that year. Compare that to an average of around 7% in 2019. With increased savings, more people — especially dual-income families — could save enough money for a sizable down payment and closing costs.
Next, PMI is a PITA
If you put less than 20% of the home’s asking price as a down payment, you’re going to have to pay monthly mortgage insurance. That’s regardless of whether you have an FHA loan or a Conventional loan.
That’s because borrowing money to buy a home when you don’t have the full 20% of the property’s asking price to use as a down payment makes you a bigger risk to a lender. Private mortgage insurance (PMI) helps offset that risk and makes a lender more likely to approve your home loan application. But, PMI involves an upfront funding fee at closing and a recurring annual fee of somewhere between 0.45% and 1.05%.
For FHA loans, PMI can last at least eleven years until you are allowed to cancel your policy. If you put down less than 10%, your mortgage insurance could last much longer. With conventional loans, you can cancel private mortgage insurance after you’ve reached 20% of home equity.
Lastly, lower conventional down payment options
Saving for a down payment is one of the biggest hurdles first-time buyers face, so the fewer upfront costs, the better. One of the things that make FHA loans so attractive is the 3.5% down payment option. That’s low.
However, other loan products have been introduced with lower down payment options over the last decade. For example, Fannie Mae and Freddie Mac now offer loans with just 3% down. And some loans come with zero down! That opens the floodgates to many more prospective buyers thinking about non-FHA-type loans.
So, should you consider a conventional loan?
If you can save enough money to purchase a home without the help of an FHA Loan, it might be wise to look at your conventional loan options. Even if you can’t afford the full 20%, using a conventional loan could help you save more money over the long term due to its cancellable mortgage insurance. However, if you don’t plan to stay in your home very long, an FHA Loan could be the better choice. Here’s what to think about:
With conventional loans, PMI is not permanent and may not even be required
With FHA loans, there’s no getting away from PMI, but with conventional loans, it’s not required if your down payment is equal to 20% or more. If you take out a conventional loan with less than 20% down, you can still cancel PMI once the remaining principal of the mortgage drops to 78%. With FHA loans, you’ll be required to pay your monthly PMI throughout the life of the loan — it cannot be canceled.
With conventional loans, there are more options
With conventional financing, you might be offered an adjustable-rate mortgage, and loans are generally available on a wider variety of property types like investment properties and vacation homes. FHA loans are not available for anything other than primary residences that are owner-occupied.
With conventional loans, property requirements are more relaxed
Property conditions come under intense scrutiny with an FHA loan: they often require specific repairs to be made before you can close on the property. This can scare off a seller who, if repairs are significant, may step back from the deal. Instead, conventional loans typically have fewer and less restrictive property requirements.
With conventional loans, condos are easier to fund
With an FHA loan for a condo, the Federal Housing Administration must approve the condominium project for a borrower to get the funding to purchase it. However, with conventional loans, if the lender can certify that the condominium project meets specific “industry” standards, the mortgage gets a green light.
Knowing what type of home loan to choose can be difficult when there are a variety of options. And it always depends on necessity, that is, which program type most closely fits your situation. For example, if cash to close is a problem, you’ll most likely be directed into an FHA loan.
Understand the requirements of each and be honest with yourself about your financial situation — that’s the only way to know the best loan for you and your family. Luckily, you now at least understand the difference between an FHA loan and a conventional loan product. And remember, a local Movement loan officer is a phone call away to help you out.