Are FHA Mortgages Still Competitive?

by Gina Pogol
April 13th, 2010

The FHA versus conventional financing decision has taken a new turn. Before the nation’s housing market began to sour, FHA was far from the most popular financing option. Three percent down was no bargain when there was 100% financing available. Fannie Mae offered its Flex 97 program and didn’t require upfront MIP. And if you wanted to put nothing down and didn’t have a job, well, there were plenty of mortgage lenders that didn’t require all that silly income documentation that FHA did.

Then, things changed, and FHA became every home buyer’s new best friend. And now, they’ve changed back–sort of.

In 2008-2009, FHA loans became the financing of choice for just about anyone with less than 20% down. Fannie and Freddie were still willing to approve high-LTV loans — subject to mortgage insurance — but insurers weren’t biting, especially on distressed markets, condominiums, or manufactured housing.  And then Fannie and Freddie adopted risk-based pricing models, meaning that if there wasn’t a halo floating above your head you’d be subject to some pretty hefty surcharges. Finally, homeowners desperate to refinance into some of the lowest mortgage rates in history discovered they had next to no home equity and FHA was the only game in town.  Today, the pendulum is swinging back.

FHA has increased its upfront mortgage insurance premium (MIP) from 1.75% to 2.25%. And while the “official” minimum credit score to get a loan with a 3.5% down payment is 580, the reality is that most lenders require credit scores of 620, 640, even 660 to approve your FHA loan. Average credit scores for FHA borrowers have risen from 621 a couple of years ago to 693 by the end of 2009. Those with lower credit scores will need to put at least 10% down to stand a chance.

Meanwhile, Fannie and Freddie are getting friendlier. Mortgage insurers like Genworth Financial are back in the game, and Genworth expanded its underwriting guidelines effective this month, with lower credit score requirements, increased availability of coverage (rules for distressed real estate markets were abolished), and offering insurance for mortgages on condos, coops, duplexes, and manufactured housing.

In addition, Freddie Mac announced the approval of Essent Guaranty to write mortgage insurance policies, joining designated affiliates of mortgage insurers Republic Mortgage Insurance Corporation (RMIC),and PMI Assurance Co. (PMAC). This means, according to Freddie, increased availability of mortgage insurance for qualified borrowers with limited down payment resources. So lenders are able to fund mortgages with higher LTVs, and no upfront MIP is required, only monthly charges.

How do you choose? Run the numbers.

Conventional financing has one set of costs and FHA financing has another. Compare them both to see which loan is the better deal. To see what your costs would be for a Fannie Mae loan, you need to look at the Loan Level Pricing Adjustment (LLPA) matrix. The charges listed can be added to your loan fees or absorbed by the lender if you accept a higher mortgage interest rate. Let’s say you have a 720 credit score and have 5% to put down. Your costs will look like this:

  • Adverse market delivery charge: 0.250%
  • Mortgage insurance: 0.94% of your mortgage balance per year.

On a $200,000, 30-year fixed rate mortgage at 5%, you’re looking at $500 in extra fees and a payment of $1,191 a month (the rate with MI is 5.94%).

Next, look at an FHA loan with the same 5% down payment. You can finance the 2.25% upfront insurance premium (which is what most people do), so your loan amount becomes $204,500. In addition to the upfront premium, you pay 0.50% per year (0.55% with less than 5% down). So, a loan amount of $204,500 and a rate of 5.55% gets you a monthly payment of $1,168.

More to Consider

An additional consideration is how soon you plan to sell your home and how fast you think your home will appreciate. FHA mortgage insurance is required for a minimum of five years regardless of your property’s value, and the upfront MIP is not refundable even if you sell the home in the first year. In addition, if you finance your upfront MIP, you lose $4,500 in home equity. You can drop traditional MI in two years if you have 22% equity.

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