Should I Use an FHA Loan or a Conventional Loan in California?

This is the part that actually decides most FHA versus conventional decisions, and it is the part most buyers never fully understand.

FHA loans require mortgage insurance no matter your credit score. It comes in two parts. An upfront premium of 1.75 percent of the loan amount, which is typically rolled into the loan balance rather than paid in cash at closing. And an annual premium, paid monthly, that ranges from 0.15 to 0.75 percent of the loan balance depending on your loan amount, term, and down payment.

Conventional loans only require private mortgage insurance if you put down less than 20 percent, and the cost of that insurance is tied directly to your credit score. The lower your score, the higher your PMI. The higher your score, the lower it gets, sometimes dramatically.

Here is where it gets interesting. For a borrower with a 640 credit score putting 5 percent down on a $700,000 loan, conventional PMI might run around 1.15 percent annually, which works out to roughly $670 per month. The same borrower on FHA, with an annual MIP around 0.55 percent, would pay roughly $321 per month. FHA is significantly cheaper on a monthly basis for that borrower.

Now take a borrower with a 740 credit score on the same $700,000 loan. Conventional PMI at that score might run closer to 0.4 percent annually, around $233 per month, and it cancels automatically once they reach 22 percent equity, generally within 8 to 10 years on a typical amortization schedule with some appreciation. FHA MIP for that same borrower would still run around $321 per month, and if their down payment was less than 10 percent, it does not cancel at all for the life of the loan unless they refinance.

That is the breakpoint. At lower credit scores, FHA's flat-rate insurance beats conventional's credit-based PMI. At higher credit scores, conventional's cancellable PMI wins, sometimes by a wide margin over the full term of the loan.