Here’s some potentially good news for anyone without high credit scores who is seeking a low-down-payment mortgage: The Federal Housing Administration is cutting its mortgage insurance premium charges, making its loans a little more affordable.
But if this sounds attractive, be aware that it may be temporary. Although the Obama administration scheduled the reduction to take effect on new FHA loans insured on or after Jan. 27, there could be a problem. Key House Republicans have objected to the cost reduction and are pressing the incoming Trump administration to reverse it. At his confirmation hearing, Ben Carson, nominee to be the new secretary of the Department of Housing and Urban Development, said that, if confirmed, he would “examine” whether it’s a good move or not.
The premium reduction is not huge — just one quarter of 1 percentage point off the previous charge — but it will lower FHA monthly mortgage payments at a time when the rest of the market is trending costlier because of rising interest rates.
Consider a scenario prepared for this column by Michael Zimmerman, senior vice president of MGIC, a major private mortgage insurer based in Milwaukee.
Say you want to buy a house and find one for $220,000, which is slightly below the median national selling price of existing homes at the end of last year. You’ve got a 720 FICO credit score and can make a down payment of 5 percent, resulting in a loan amount of $209,000. Before the cut in FHA fees, at typical interest rates quoted earlier this month, you would have paid $1,153 monthly (exclusive of property taxes and hazard insurance) for an FHA-insured mortgage. The same loan but with private mortgage insurance would have cost $2 more a month — $1,155. On monthly payments, your FHA loan and a conventional Fannie Mae/Freddie Mac alternative would have cost about the same.
After the premium reduction, however, the monthly cost for the FHA loan would be $45 cheaper than the competing conventional loan — a cost advantage of $540 the first year. For larger loans, the savings would be greater. No big deal? It depends: For new home buyers short of cash, any savings can be important. Also, the lower mortgage cost improves the buyer’s debt-to-income ratio, a crucial factor in loan approvals.
What about first-timers who can’t come up with any more than the absolute minimal down payment allowed on either FHA (3.5 percent) or Fannie/Freddie conventional mortgages (3 percent)? Here the cost differentials become significantly greater.
Assume that you have a 720 FICO score and you’re purchasing the same $220,000 house with an FHA loan and a 3.5 percent down payment. That would cost you $129 less per month following the premium reduction compared with a 3 percent down conventional loan, according to an analysis prepared by Paul Skeens, president of Colonial Mortgage Group, a lender based in Waldorf, Md. The FHA payment comes to $1,088.45, the conventional loan payment to $1,217.45.
You might say, wow, it looks as if for new low-down-payment buyers, FHA is always the way to go. But that’s not the case. Keep these pros and cons in mind when you comparison shop for a mortgage requiring minimal dollars down:
▪ Both FHA and conventional loans require payment of mortgage insurance premiums. But FHA loans come with a glaring negative: Unlike private mortgage insurance, FHA premiums are noncancelable for the life of the loan if you make a down payment of less than 10 percent. With a conventional loan, you get to cancel your premium payments when you achieve a 20 percent equity stake in the house. That can occur when your principal payments reduce your debt to 80 percent of the original balance or when an increase in the market value of your house grows your equity. When your loan balance declines to 78 percent — your equity is 22 percent — your loan servicer is required by federal law to terminate premium payments.
▪ On the plus side, FHA has far more generous and forgiving underwriting rules on credit, debt-to-income ratios and financial assistance from home sellers to help with buyers’ closing costs. It exists to serve working families and individuals who might otherwise find it difficult to get an affordable loan. If your FICO credit score is below 720 and you can cobble together a 3.5 percent down payment, FHA is usually the right choice. The new, lower premiums merely underline that fact.