If you saw the White House announcement of lower insurance payments on Federal Housing Administration home mortgages last week, you might have wondered: Does this matter to me as a potential homebuyer or refinancer? Who specifically will benefit from the decrease in fees?
The Obama administration estimates that by lowering FHA’s annual mortgage insurance premiums by half a percentage point, as many as 250,000 new buyers will be able to purchase a house. That’s great news and overdue. FHA almost priced itself out of competition with giant investors Fannie Mae and Freddie Mac by raising its premiums several times in recent years. FHA made itself too expensive and its market share has plunged.
So who is best positioned to take advantage of the new, more consumer-friendly mortgage pricing? Here’s a quick overview. Start with your FICO credit score. If you’ve got a score anywhere from 620 to 719 and you have a down payment of 5 percent or less, FHA is likely to become your first choice in terms of monthly payments. It will cost you less in principal, interest rate and mortgage insurance charges compared with what you’d pay for a “conventional” loan eligible for purchase by Fannie Mae or Freddie Mac with private mortgage insurance.
Consider this example using data provided by MGIC, one of the major private insurance underwriters. Say you want to buy a $220,000 first home with a 5 percent down payment. You’ve got a slightly below average FICO score between 680 and 699. Before the premium reduction, your monthly payment using a 30-year FHA loan at current interest rates would have been $1,225. The same conventional loan with private mortgage insurance would have cost you $1,168 a month — $57 less than FHA. After the premium reduction, the monthly payment on the FHA loan will drop to $1,138 — $30 cheaper than the conventional alternative.
But what if you’ve got a higher FICO score? On the same 5 percent loan and rate and term assumptions as above, with a FICO score of 729 to 759, your monthly payment should be lower with a conventional loan. You’d pay $1,106 a month compared with $1,138 — $32 more — for an FHA-insured mortgage with the reduced premiums. At 760 and above, the payment drops to $1,092. So FICOs matter.
What other factors might influence you to opt for an FHA loan over a competing conventional mortgage and vice versa? There are several important issues to consider. FHA is more flexible when it comes to underwriting. Take debt-to-income ratios. Conventional lenders using private mortgage insurance typically will not approve you if the ratio of your recurring monthly debt payments to your documented monthly gross income exceeds 45 percent.
FHA, by contrast, may stretch that if other aspects of your application — steady income, reasonable financial reserves — look strong. Some lenders say they can squeeze their FHA applicants through with debt ratios higher than 50 percent — one lender told me he’s done 56 percent. Plus, FHA is more sympathetic in the way it treats one of the biggest obstacles facing many millennial applicants — student debt. According to Paul Skeens, president of Colonial Mortgage Group in Waldorf, Md., buyers whose student debts have been deferred for 12 months or more won’t have them factored into the application, whereas conventional lenders include them.
Some downsides of FHA? Tops on the list: It charges borrowers an upfront premium of 1.75 percent that typically gets tacked onto the principal they’re borrowing, financed over the term of the loan. FHA could have, but did not, lower that fee.
Why’s that significant? Because unlike private mortgage insurance, which by federal statute can be canceled once a borrower’s equity position reaches 20 percent of the home’s value, FHA’s premiums on most loans continue for the life of the mortgage. That add-on to principal stays with you for years beyond the date you’d be able to cancel your private insurance payments, which in some scenarios can be as early as four to five years. Put another way: You will build equity in your home faster with a conventional loan compared with FHA.
Bottom line: If you have a FICO score well above 720, and you’ve got money for a 5 percent down payment and a debt ratio below 45 percent, conventional is probably your better bet. But if your FICO is in the 600s and you have some complications to your application or debt issues, FHA will probably treat you kindlier.
Kenneth R. Harney of the Washington Post Writers Group is a past member of the Federal Reserve Board’s Consumer Advisory Council and is currently on the board of directors of the National Association of Real Estate Editors.