If you’re planning to buy a home with a low down payment, you need to be aware of some important – but virtually unpublicized – price changes underway in the mortgage market.
If you’ve got good but not great credit, such as a FICO score in the mid- to upper 600s, you’re going to get hit with higher fees on a conventional (nongovernment) loan with a low down payment. Count on it. On the other hand, if you’re part of the credit elite – your FICO score is 760 or higher – congratulations. You’re in line for an unexpected discount on fees, despite making a tiny down payment.
What’s going on? Put simply, the mortgage insurance premiums on loans eligible for sale to giant investors Fannie Mae and Freddie Mac underwent a shakeup earlier this month. Applicants with lower scores and smaller down payments got whacked.
To illustrate: According to one mortgage insurer’s rate sheet, a buyer of a $400,000 house with a 660 FICO, a 3 percent down payment and a fixed rate of 4 1/8 percent would have paid $2,359 a month in principal, interest and mortgage insurance before the premium changes took effect April 4. Today the same borrower would be charged $2,495 a month – $136 more a month, $1,632 more a year. But a borrower with a 760 FICO seeking the same size loan with a rate of 3 7/8 percent would now be charged $162 less per month – $2,002 versus $2,164 – because of the pricing revisions.
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What about slightly larger down payments, such as 5 percent ($20,000) on the same $400,000 home purchase? If your FICO is a 620, you would have paid $2,261 a month before the change. Now your mortgage will cost you $2,407 a month. If you’re at the higher end of the credit spectrum, with a 760-plus FICO, the 5-percent-down loan would have required $1,931 a month in payments before April 4. That now drops down to $1,890.
A little background here: When you as a borrower make less than a 20 percent down payment on a conventional loan, private mortgage insurance is required to limit some of the potential risk for the lender or investor. Typically the premiums get tacked on to the monthly payments. Fannie Mae and Freddie Mac also add their own extra charges on low down payment mortgages. The lower your credit score and the smaller your down payment, the higher the add-on fees charged by Fannie and Freddie.
Mortgage insurers say they were forced to make the pricing revisions because Fannie and Freddie rejiggered capital requirements on them. “We had to end up charging more,” said Michael Zimmerman, a senior vice president at MGIC, a major insurer. The “cross subsidization” in premium rates that previously existed in pricing – where borrowers with excellent credit were charged a little more in premiums so that lower-FICO borrowers could pay a little less – has “now been eliminated.”
Fannie and Freddie officials say the revised capital requirements were necessary to ensure that the companies they deal with have sufficient strength to handle future default and foreclosure claims. Andrew Wilson, a spokesman for Fannie Mae, said the mortgage insurance companies could have revised their rates differently, limiting the impact on lower score home buyers, but chose otherwise.
Bose T. George, managing director of equity research at Keefe, Bruyette & Woods Inc., a highly regarded mortgage industry analyst, says Fannie and Freddie also had choices: They could have reduced their own “significant” fees on lower down payment, lower FICO borrowers, which they’ve had in place since the housing crisis. “They have never revised their fees, and to expect private companies to subsidize lower-score borrowers is unrealistic,” he told me in an interview.
Putting aside these inside-the-industry spats, what do the new changes in insurance premiums mean to you in practical terms? If you’ve got a FICO score in the mid- to upper 600s and you want to make as small a down payment as possible, you'll probably want to look to the Federal Housing Administration (FHA) for your financing.
FHA offers 3.5 percent minimum down payments, is more flexible and lenient than Fannie and Freddie on credit issues and debt-to-income ratios. Last year FHA slashed its own premiums and they’re now the less-costly choice below 700 FICO.
But FHA-insured loans have a key drawback: Unlike private mortgage insurance, you generally can’t cancel premium payments once your equity reaches a certain threshold. So you could end up paying monthly premiums indefinitely. That’s a real turn-off.