FHA Rate Trap: FHA vs Conventional Loan With 20% Down

FHA vs Conventional Loan With 20% Down: Payment Comparison

When comparing an FHA vs conventional loan with 20% down, the loan with the lower interest rate may not have the lower total monthly payment. Many borrowers assume that the mortgage with the lowest interest rate must be the best option. However, the interest rate is only one part of the loan’s total cost.

Consider this analysis I prepared for one of my borrowers:

Loan detail	Scenario
Purchase price	$575,000
Down payment	20%, or $115,000
Base loan amount	$460,000
Credit score	700
Debt-to-income ratio	45%
Loan term	30-year fixed

The borrower was offered a lower interest rate on the FHA loan, but the conventional loan still produced the lower initial monthly payment.

FHA versus conventional payment comparison

FHA financing

• Interest rate: 5.710%

• Principal and interest: $2,719.53

• Monthly FHA mortgage insurance: $190.74

• Total financing payment: $2,910.27

  
  

Conventional financing

• Interest rate: 6.324%

• Principal and interest: $2,854.48

• Private mortgage insurance: $0

• Total financing payment: $2,854.48

  
  

Based on the payments shown, the conventional loan saves the borrower $55.79 per month, or approximately $669.48 during the first 12 months.

Although the FHA interest rate is more than half a percentage point lower, FHA mortgage insurance causes the total payment to be higher.

Why conventional financing is the better fit in this scenario

1. A 20% down payment eliminates conventional mortgage insurance

Private mortgage insurance is generally associated with conventional loans exceeding 80% loan-to-value. Because this borrower is making a full 20% down payment, the conventional loan begins at an 80% LTV and does not require monthly PMI.

This is one of the main financial advantages of putting 20% down.

FHA financing works differently. FHA generally charges mortgage insurance regardless of whether the borrower puts down 3.5%, 10% or 20%.

2. FHA adds an upfront mortgage insurance premium

Most FHA purchase loans require a 1.75% upfront mortgage insurance premium, commonly called UFMIP. HUD permits this premium to be financed into the mortgage balance.

In this example:

• Base FHA loan: $460,000

• Upfront FHA premium: $8,050

• FHA loan after financing UFMIP: $468,050

  
  

The conventional loan starts with a principal balance of approximately $460,000, while the FHA borrower begins with approximately $8,050 more debt when the upfront premium is financed.

That additional amount also accrues interest as part of the FHA loan.

3. FHA still requires monthly mortgage insurance

For a qualifying FHA mortgage with a term longer than 15 years and an original LTV of 90% or less, the annual mortgage insurance premium is generally assessed for 11 years. The applicable annual MIP rate for a loan of this size is currently 0.50% of the applicable outstanding balance.

Therefore, even though this borrower is putting down 20%, the borrower could still pay FHA mortgage insurance for approximately 11 years.

Building additional equity does not automatically cancel the FHA insurance ahead of that scheduled period. The borrower could potentially refinance into a conventional mortgage later, but refinancing would require a new qualification, appraisal and closing costs.

4. A 700 credit score is generally considered good credit

FHA financing can be especially valuable for borrowers who need:

• A smaller down payment

• More flexible credit requirements

• Greater underwriting flexibility

• Assistance qualifying after previous credit challenges

  
  

However, those advantages may be less valuable to a borrower with a 700-credit score, a 20% down payment, and an approvable conventional loan.

In this scenario, the borrower would incur FHA mortgage insurance even though the borrower is contributing substantial equity at closing and has a solid credit profile. By comparison, a conventional loan at 80% loan-to-value generally does not require monthly private mortgage insurance.

The borrower’s 45% debt-to-income ratio must still be evaluated through automated underwriting and a complete review of the loan application. However, when the borrower qualifies for both programs, conventional financing may provide a more cost-efficient structure despite having a higher interest rate.

Do not compare mortgage rates by themselves

The FHA rate in this example is lower, but the FHA loan also includes:

• An $8,050 upfront insurance premium

• A higher loan balance if the premium is financed

• Approximately $190.74 in initial monthly mortgage insurance

• A higher initial monthly financing payment

The Consumer Financial Protection Bureau explains that the interest rate does not include all loan expenses. APR provides a broader measurement because it incorporates the interest rate and certain additional charges. Borrowers should also compare the five-year cost shown on Page 3 of each Loan Estimate.

A proper loan comparison should evaluate:

• Interest rate and APR

• Discount points

• Lender fees and credits

• Monthly mortgage insurance

• Upfront mortgage insurance

• Beginning loan balance

• Cash required at closing

• Five-year borrowing cost

• Expected length of homeownership

Could FHA still make sense?

Possibly. The FHA loan has a significantly lower note rate in this example. After the scheduled FHA mortgage insurance period ends, its continuing principal-and-interest payment will remain lower than the conventional payment, assuming the borrower keeps the original loan.

Therefore, the final decision should also account for how long the borrower expects to own the property and retain the mortgage.

FHA may also be appropriate when its underwriting flexibility is necessary for approval. But a borrower should not select FHA solely because its advertised interest rate is lower.

The Titanium Mortgage approach

At Titanium Mortgage, we do not simply recommend a loan with the lowest rate. We compare the complete financing structure to determine which option provides the borrower with the best overall result.

In this scenario, the conventional loan offers:

• No monthly mortgage insurance

• No FHA upfront insurance premium

• A lower beginning loan balance

• A lower initial monthly payment

• Approximately $669 in first-year payment savings based on the quoted figures

For a borrower with a 700-credit score and 20% down, conventional financing is likely the stronger initial option provided the borrower and property satisfy conventional underwriting requirements.

The best mortgage is not necessarily the one with the lowest rate. It is the one that best supports the borrower’s payment, equity, financial goals and expected ownership period.

Contact Titanium Mortgage

Before selecting FHA, conventional or another loan program, request a side-by-side mortgage analysis from Titanium Mortgage.

Titanium Mortgage 713-524-4242 www.tmortgage.net

Illustration only and not a commitment to lend. The payment difference shown is $55.79 based on the displayed payments of $2,910.27 and $2,854.48. Figures assume a $575,000 purchase price, 20% down and a 30-year fixed-rate mortgage. Property taxes, homeowners’ insurance, HOA dues, APR, points and other closing costs are not included in this comparison. Rates, payments and program requirements are subject to change. All loans are subject to borrower, property and underwriting approval.