Do FHA home purchase loans have higher costs than conventional home loans?

Find out how FHA closing costs are higher than closing costs from conventional loan programs

In a word, yes. The overall costs for FHA home purchase loans are definitely higher than conventional home loans. However, over the long term FHA loans can actually be less expensive than conventional loans from Fannie Mae or Freddie Mac if you are making a down payment of less than 20% when you buy a home.

Why are FHA home purchase loans more expensive?

FHA home purchase loans have higher closing costs than conventional loans because all FHA loans have an up-front mortgage insurance premium of anywhere between 1.5% and 3.5% of the loan amount due at closing. Most borrowers do not feel this cost because this fee is actually added to the loan amount and does not have to be paid as part of the closing costs at closing.

If you take out an FHA home loan and then sell your home down the line, your loan amount to pay off at closing will be higher than a conventional home loan because you will have that FHA mortgage insurance premium that was tacked on at your closing.

Despite the extra costs, for many first-time home buyers the FHA mortgage program is the only game in town, so the extra costs are really irrelevant because no conventional home loan option was available anyway.

To compare whether or not an FHA mortgage is best for you despite the higher costs, home buyers need to look at why they might need an FHA home purchase loan. The four main reasons why home buyers choose the FHA program are:

1. Low Down Payment. FHA loans require a down payment of only 3.5%, while Fannie Mae and Freddi Mac require at least a 5% down payment on most programs. In addition, getting approved for a loan with only 5% down is harder than it has ever been, while FHA qualifying standards have remained essentially the same over the past two years.
2. Down Payments Can Be a Gift. Home buyers who are getting a gift for their down payment can use that gift for a down payment with an FHA purchase loan. For conventional loans, at least a 5% down payment from the borrower's own funds is required.
3. Lower Credit Score Requirements. FHA loans only require a 620 credit score (and only 600 for a few select lenders with compensating factors). Borrowers who need private mortgage insurance for a conventional loan will need at least a 680 and usually a 700 credit score to qualify.
4. Monthly mortgage insurance costs are much lower than Private Mortgage Insurance. Over time, the monthly FHA mortgage insurance premium is much lower than current private mortgage insurance options. In many cases, the private option can be as much as double the monthly FHA premium.

So if you have a low down payment that is a gift and have a credit score below 700 then the FHA mortgage program is your only option. If you are putting down 20% or more, then most likely a conventional rate loan will be less expensive because you will not have to pay any upfront or monthly mortgage insurance payments.

One extra incentive for home buyers: Even though the large up-front mortgage insurance premium gets tacked on to the loan amount of an FHA home purchase loan, home buyers will receive a partial refund for the unused portion of that payment if they sell their home before the end of the loan term.

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