The cost of a mortgage just went up for Federal Housing Administration (FHA) borrowers. On April 5, 2010, the FHA increased its upfront mortgage insurance premium (MIP) from 1.75% of the loan amount to 2.25%. In addition, FHA borrowers with 30-year mortgages also pay an annual MIP of 0.5% of the loan balance. FHA is petitioning Congress to allow an annual premium increase to 0.9% for those who put 3.5% down and to drop the upfront MIP to 1% of the loan amount.
Example of FHA Loan with New MIP
On a $300,000 mortgage, the upfront MIP increase means a payment of $6,750, up from $5,250. You are not required to come up with that cost out of pocket, and most people don't. Instead, you can opt to add the MIP to your mortgage balance and finance it.
With the help of HSH.com's amortization calculator, you can see what the payments would look like for someone buying an approximately $311,000 home at 5.5% with a 3.5% down FHA loan:
- Base mortgage amount: $300,000
- Upfront mortgage insurance at 2.25% of base loan amount: $6,750
- Total loan amount: $306,750
- Annual mortgage insurance at 0.5% of $300,000: $1,500, or $125 per month
- Principal and interest payments on $306,750 loan at 5.5%: $1,742
- Total monthly payment: $1,867
Here's what the same loan will cost if Congress approves the additional changes to the FHA's mortgage insurance premium structure:
- Base loan amount: $300,000
- Upfront mortgage insurance at 1% of base loan amount: $3,000
- Total loan amount: $303,000
- Annual mortgage insurance at 0.9% of $300,000: $2,700, or $225 per month
- Principal and interest payments on $303,000 loan at 5.5%: $1,720
- Total monthly payment if changes enacted: $1,945
So, there is a smaller cost to get into the mortgage, but your initial monthly payment will be higher if FHA gets the changes it wants.
However, that isn't the only consideration. Annual MIP is calculated on the mortgage balance and goes down each year. In addition, the Department of Housing and Urban Development (HUD) says that you can't cancel the MIP within the first five years, yet after that, you can cancel once your loan-to-value decreases to 78%.
Are You Worse Off with New FHA Premiums?
If you plan to accelerate your loan's payoff or don't expect to keep your home more than a few years, the shift of mortgage insurance from upfront to annual may cost you less than the current structure. If minimizing your monthly payment is your main consideration, you should get your FHA case number and get your mortgage in process before more changes go through.
As an alternative, consider putting 5% down and applying for a conventional mortgage. There is no upfront MIP on Fannie Mae or Freddie Mac loans, and mortgage insurance on conventional mortgages is becoming more widely available. Also, the monthly cost is similar to that of FHA's proposed monthly rates. A look at one insurer's rate card shows a premium of 0.98% on a 95% loan-to-value mortgage.
Seller Concessions to Drop
In addition to paying more for MIP, borrowers under the new FHA guidelines will be subject to other considerations. First, under the new rules, sellers are limited to a maximum concession of 3% of the buyer's closing costs instead of 6%. This change brings FHA policy in line with the requirements of non-government lenders. The idea in making the change was to reduce excess risk to FHA by requiring borrowers to have more "skin in the game," in other words, putting more of their own money into the transaction.
HUD data supports this claim of added risk, indicating that mortgages made on sales with higher seller concessions end up in foreclosure 50% more often.
Minimum Credit Scores to Rise
Borrowers with credit scores lower than 580 will be required to put a minimum of 10% down to get an FHA mortgage, and those with scores lower than 500 will be precluded from obtaining FHA financing altogether. However, the effect of this change may be minimal, as many mortgage lenders already impose a 620-to-660 minimum credit score requirement on their FHA borrowers. In fact, according to HUD, the average credit score of an FHA borrower has increased steadily from 622 in February 2008 to 693 in February 2010.
Why would a lender's requirements be more stringent than FHA's? Mortgage lenders with higher-than-average default rates for their area may have their FHA approval taken away, even if they follow FHA guidelines when underwriting home loans. Many FHA-approved lenders choose to protect their approval by overlaying more stringent guidelines on top of the FHA's requirements.
A Healthier FHA Is Good for All
The FHA is vital to making homeownership available for many people in the U.S. The agency helps an underserved part of the population overcome the biggest hurdle to buying a home -- the down payment -- and performs a crucial role in supporting the housing market. These changes will help the agency improve its fiscal position to be able to continue carrying out its mission in the years ahead.
Gina Pogol has been writing about mortgage and finance since 1994. In addition to a decade in mortgage lending, she has worked as a business credit systems consultant for Experian and as an accountant for Deloitte.
