Until recently, FHA mortgages were less popular than conventional mortgages because they require both upfront and monthly mortgage insurance premiums, full documentation of income and assets, and limit the amount you can borrow. It also used to be that FHA mortgage rates were higher than conventional rates. But times have changed.
FHA loans: from mortgage wallflower…
In 2005 and 2006, at the height of the housing boom, only 1.8 percent of all mortgages were FHA-backed. Why? Because the FHA, Fannie Mae and Freddie Mac were all offering mortgages with just 3 percent down. Furthermore, FHA loans require upfront and monthly mortgage insurance premiums. Back in 2005 and 2006, 100 percent mortgages and "80/20" programs (requiring no mortgage insurance at all) were plentiful and easy to find. At the time, it was also easy to find loans requiring little to no income verification.
So why go through the stodgy FHA with its insurance requirements, full documentation and borrowing limits? In fact, the only borrowers who did were those with average credit scores of 621 and limited resources.
…To homecoming queen
Things changed real fast when the mortgage crisis hit and Fannie Mae and Freddie Mac clamped down. The GSEs implemented risk-based pricing, which significantly jacked up the cost of getting a mortgage (until recently, Fannie and Freddie controlled 90 percent of the mortgage market). In fact, to dodge all of the new fees, you'd have to purchase your home with at least 40 percent down (or refinance with at least 40 percent equity) and have a credit score of at least 700.
The result was that conventional financing became much more expensive for people. Yet while Fannie and Freddie were undergoing all these changes, FHA mortgages barely changed at all and did not have any of these extra charges. It didn't take long for borrowers to fall in love with FHA mortgages. In 2010, FHA loans financed nearly 40 percent of home purchases with average credit scores over 700.
FHA mortgage rates offer an advantage
If you look at HSH.com's historical mortgage rates, you can see how the relationship between FHA mortgage rates and conforming mortgage rates has changed.
From the height of the housing boom in 2006 through the mortgage crisis, FHA mortgage rates were higher than their conforming counterpart most of the time. However, as the mortgage crisis changed the landscape of the industry, conforming mortgages became relatively more expensive, and the relationship shifted. Since March 2010, 30-year FHA loans have had lower interest rates than conforming loans.
If you have a fair credit history, a small down payment or little home equity, the difference may be even more pronounced. Fannie Mae's risk-based pricing means that if you have a 659 credit score--which would have been good enough for approval in the not-so-distant past--and 15 percent down, you'd get hit with an extra 3.25 percent in fees. That's nearly $10,000 on a $300,000 loan, in addition to the customary charges.
High fees=higher rates
That extra 3.25 percent doesn't have to be paid out of pocket by the homebuyer, however. The lender can pay it instead, if the buyer accepts a higher mortgage rate. That 3.25 percent in fees could be traded off for a roughly 0.75 percentage point increase in the mortgage rate. As borrowers choose higher mortgage rates to pay for the extra loan fees, Fannie and Freddie mortgage rates have crept up.
You don't get hit with these extras when you choose an FHA mortgage, and that's how FHA mortgage rates have become cheaper than Fannie Mae and Freddie Mac rates today.
Getting an FHA loan
To get started on an FHA loan, check first that your mortgage balance would fall within the FHA loan limit for your area. Then, when you compare mortgage quotes, make sure you contact qualified FHA lenders as well as conventional mortgage lenders.
You may be surprised which loan is your best bargain in today's mortgage market.
