The new normal: FHA mortgage rates lower than conforming rates?

by Gina Pogol
January 24th, 2011

Before the housing crisis, conventional (non-government) mortgages were a lot more popular than FHA home loans. They were generally cheaper to obtain, you didn’t need a down payment, and you often didn’t need to prove your income.  The annual percentage rates (APRs) of conventional mortgages, which included mortgage insurance when applicable,  were generally lower on than they were with FHA mortgages, which include monthly mortgage insurance plus an upfront mortgage insurance premium. However, today the reverse is often true.

Why are FHA mortgage rates lower than conventional mortgage rates?

Three years ago, FHA mortgages made up a very small part of mortgage originations — less than 2 percent in 2005 and about 7 percent in 2007. FHA borrowers’ credit scores averaged 621 three years ago, and only folks who needed extra underwriting flexibility bothered with FHA home loans.

That was then, this is now

Back then, Fannie Mae and Freddie Mac offered prime lending products to people with 620 credit scores as well as folks with 800 credit scores, and the people with very high scores paid about the same for their loans as the borrowers with low scores. In the wake of the mortgage mayhem, they analyzed their data and found that (this is shocking, I know!), people with low credit scores defaulted at a higher rate than those with excellent credit.

So today, Fannie Mae and Freddie Mac use a schedule of price increases (called LLPA or Loan Level Pricing Adjustment Matrix) based on credit scores, loan-to-value ratios, and property types and use. The risk-based pricing tiers shift at each 20 point change in credit score. For example, if your score is 640, you may need to pay a surcharge of 3 points at the closing or accept a higher interest rate. If your score is 680, the adjustment drops to 1.5 points at closing.

Here is an illustration of how risk-based pricing drives mortgage rates, according to MyFICO.com, using national mortgage rates from Jan. 21, 2011.

FICO APR Payment
760-850 4.397% $2,002
700-759 4.619% $2,055
680-699 4.796% $2,098
660-679 5.010% $2,150
640-659 5.440% $2,256
620-639 5.986% $2,395

Mortgage News Daily published Jan. 21, 2011 mortgage rates for FHA 30-year loans at 4.72 percent,  while the best conventional mortgage rates came in at 4.85 percent.  So, using those figures, you can see that people with credit scores below 700 on that date were probably better off selecting an FHA mortgage than they’d be going with a conforming mortgage.

This is born out with another fact — specifically the fact that over the last three years the average credit score of FHA borrowers has risen from 621 to just over 700. Unless your score is over 760, and you have a 20 percent down payment, and are purchasing a single family residence, you won’t be offered the best mortgage rates by a conventional lender.  FHA lenders, conversely, don’t add extra costs other than mortgage insurance which is paid by all borrowers regardless of down payment size or credit rating.

When you  shop for a mortgage, make sure the loan agent knows what your credit score is so that you get an accurate quote; then compare conventional mortgage quotes to FHA quotes before choosing your next home loan.

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