If you are considering a Federal Housing Administration loan to finance a home purchase, it is prudent to compare FHA rates vs. conventional rates for home loans, in addition to examining all costs involved with each type of loan. The interest rate you secure with your home loan determines the amount of your monthly mortgage payments, as well as how much you will pay over the life of the loan.
The two primary types of interest rates are fixed and variable, both of which are available with either conventional or FHA home loans. A fixed interest rate is set at the time your loan is originated, and the rate remains fixed for the life of the loan. A variable interest rate loan, also known as an adjustable-rate mortgage, fluctuates over time, usually based on a financial index like the prime rate given to banks’ best customers. A variable interest rate can be substantially riskier than a fixed-rate loan, as variable rates may start off exceptionally low but can also rise substantially in the future, making your mortgage payments difficult or impossible to make.
Conventional rates for home loans are largely driven by borrowers’ credit scores. To obtain the best possible interest rates available at any given time, you need to have a Fair Isaac Corp., or FICO, credit score of 720 or higher. With a conventional home loan, the lower your credit score, the higher the interest rates offered by lenders. A conventional loan typically requires a 20 percent down payment for a home purchase loan to get a better rate and a minimum of an 80 percent loan-to-value ratio -- the loan amount is no more than 80 percent of the home’s value -- for a home refinance loan.
There are no credit score requirements for FHA loans, and qualification guidelines are significantly more relaxed overall when compared with conventional home loans. FHA rates may be slightly higher vs. the better conventional rates, but FHA home loans require a mere 3 percent down payment, and the FHA ensures its rates stay competitive with conventional interest rates. Refinance and cash-out refinance loans can be obtained with the same competitive FHA rates, low closing costs and lenient income and credit qualifications. However, FHA streamline refinancing requires that your original mortgage be an FHA-insured loan.
FHA 2-1 Buydown
An FHA 2-1 buydown loan gives you the opportunity to “buy down” your interest rate for the first two years of the loan. For the first year your interest rate is lowered to two percent less than the initial or note rate. The interest rate is 1 percent below the note rate during the second year, and thereafter, it goes up and remains at the note rate. You buy down the interest rate by providing additional funds that are placed in a buydown account, used to supplement your monthly mortgage payments for the first two years. Conventional home loans also offer opportunities to buy down your interest rate, with the purchase of discount points that are paid at the closing of your loan.
Based in California, Debbie Donner is a freelance online writer who primarily writes articles related to personal finance. Donner received a Mensa scholarship in 2006 while attending California State University, Fresno. She holds a Bachelor of Arts degree in liberal arts and a multiple-subject teaching credential.