It's Back!

For several years I’ve been recommending to anyone with a decent credit score that they do whatever they can to come up with a 5% down payment to avoid FHA financing. As the mortgage insurance charged by FHA continued to become more and more expensive, that type of financing became somewhat of the “new sub-prime” loan for those with minimal down payment and poor credit scores. However, with the introduction of the new monthly fee for mortgage insurance being charged at 85 basis points versus 135 basis points (see my update from two weeks ago – it goes into effect January 26th), FHA is back in business!

FHA has once again moved to the forefront of viable loan options for first time buyers and move up buyers with minimal proceeds coming from selling their current home. If FHA continues to price their loans competitively from a rate perspective, an argument can be made for anyone with a smaller down payment to consider this option over a conventional loan. For the past several years, the 30 year fixed rate for an FHA loan has been around .5% better than a conventional 30 year fixed. So right now, someone with good credit can get a conventional loan at 3.75% or an FHA at 3.25%. If the loan amount were $150,000 for each, the P&I would be $42 cheaper on the FHA due to the lower rate. For the very best credit scores, the MI factor is still around 30 basis points higher on FHA versus a 95% conventional loan, so for the same loan amount, the borrower would pay $37 more for the FHA loan. FHA still wins by $5 – and this is for borrowers with the best credit scores. As the credit score gets lower, the impact to both the rate and the MI for conventional is significantly greater than FHA. FHA only requires 3.5% down and for the most part, offers more lenient underwriting guidelines than conventional loans.

Fannie and Freddie made big announcements back in the fall that they’d be rolling out new 97% loan options this year. I can assure you that the rates and MI costs for those higher loan to value loans will be greater than what they are at 95%. With the new change FHA has made, it may render Fannie and Freddie’s 97% loans pretty insignificant.The one major argument that is still in favor of a conventional loan is that the monthly mortgage insurance can be removed at some point in the future (minimum of two years), whereas the FHA monthly mortgage insurance payment is permanent. But in most cases, it is at least 4-5 years down the road before that is possible on the conventional loan, and the average first time buyer isn’t in a home much longer than that anyway.

And don’t forget that FHA loans are assumable (on a qualifying basis). If rates go up in the next few years, even if only to the 5.5 - 6% range, how attractive might a house be to a buyer if he/she can assume the existing loan at 3.25%? Something else to think about...

Oh, one more thing – you might suggest to anyone that purchased a home in 2013 or 2014 using an FHA loan, to consider refinancing that loan to take advantage of the lower MI.