Blog posted On March 30, 2021
The FHA Loan has been a cost-effective staple for first-time home buyers since its creation in the 1930s. With low down payments and lenient credit requirements, the FHA Loan has helped millions of home buyers over the years. However, recent data by the National Association of REALTORS® (NAR) has shown a sharp decrease in the number of buyers who are financing their first homes with the FHA Loan. Over the past 1-2 years, more first-time buyers have been choosing the conventional financing route – but why? When might a conventional loan be a better option for first-time buyers?
Recent first-time buyer financing trends
In 2012, almost half of all first-time home buyers financed their homes with FHA Loans. Seven years later, that number saw a sharp drop to 30%, and in 2020, it slipped once again to 29%. By 2021, the number of first-time buyers financing with an FHA Loan is down to 24%
Conversely, the number of first-time buyers using conventional loans has shot up over the past several years. In 2018, a little more than half of first-timer buyers bought with a conventional loan. In 2021, nearly 60% are choosing to finance conventionally.
Why are more first-time buyers using conventional loans?
Mortgage insurance is typically required for both FHA Loans and conventional loans if you put less than 20%* down on your home. For FHA Loans, you will pay a mortgage insurance premium (MIP) – which involves an upfront funding fee at closing and a recurring annual fee thereafter. The funding fee is around 1.75% of the home’s purchase price and the recurring fee is typically between 0.45% and 1.05%. For a $400,000 home, that’s $1,800 to $4,000 every year – lasting at least 11 years until you are allowed to cancel your insurance. However, if you put down less than 10%* you won’t have the option to cancel your MIP, even after 11 years. With conventional loans, you can cancel your private mortgage insurance (PMI) after you’ve reached 20%* equity.
In other words, some buyers are finding that they can save more insurance money over time by financing with a conventional loan. Gay Cororaton, research economist for the NAR, outlined an example where borrowers could save more than $15,000 on insurance by financing with a 30-year conventional loan instead of a 30-year FHA Loan. However, the savings depend on how long you keep your home. Conventional loans tend to have greater upfront charges than the first few years of paying for an FHA mortgage.
2. Lower conventional down payment options
One of the larger appeals for FHA Loans is the low-down payment option of 3.5%*. The FHA Loans used to be one of the few financing options with down payments that low. However, in 2014 Fannie Mae and Freddie Mac approved their 3%* down payment products, rivaling the FHA option. The older that these conventional products become, the more popularity they gain – especially among first-time buyers. Saving for a down payment is one of the biggest hurdles first-time buyers face, so the fewer upfront costs, the better.
3. Coronavirus savings
While millions of people have been financially struggling during the pandemic, millions of others have saved. According to the Federal Reserve, the average savings rate in 2020 reached 17.2% – the highest level by far over the past 20 years. In comparison, the savings rate in 2019, just prior to the pandemic, was 7.9%. Over the past decade it’s hovered around 7% and from 2000 to 2010 it trended between 3.2% and 6.6%.
Over the past year, many Americans have been able save $2,000 each in commuting costs alone. With the addition of the economic stimulus packages (totaling at $3,200 together) and reduced costs like eating out or other social activities, some people have been able to save enough money for a down payment without the help of an FHA Loan.
When to use a conventional loan vs. an FHA Loan
If you can save enough money to purchase a home without the help of an FHA Loan, it might be smart 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, then an FHA Loan could be the better choice.
If you would like help evaluating your choices and comparing your savings between FHA Loans and conventional loans, let us know and we will be happy to compare your options with you.
*Payment example: If you choose a $250,000, 30 year loan at a fixed rate of 3.3% (APR 3.5%), with a loan-to-value of 80%, you would make 360 payments of $1,122.61. Payment stated does not include taxes and insurance, which will result in a higher payment.
Sources: The Mortgage Reports, Money, NAR, Time