Homebuyers with less than a 20% down payment for a new home purchase have historically sought a loan backed by the Federal Housing Administration (FHA) because of its 100% financing feature.
Unlike conventional mortgages, FHA loans allow the borrower to obtain a mortgage with as little as 3.5% down. The underwriting process is less strict than what is typically associated with a conventional loan and has been a staple product for low-income buyers.
Prior to 2008, only 10% of all mortgage loans were FHA backed, however, once the housing bubble burst, mortgage requirements tightened to the point where an increasing number of homebuyers turned to the FHA as their only alternative. Approximately 40% of mortgage loans in 2009 were FHA insured; however this trend has since declined.
A primary reason for the decline is due to the increase in mortgage insurance premiums and a new rule that no longer allows borrowers to opt out of mortgage insurance after establishing a steady record of payments.
Newsday reports that FHA borrowers are charged an annual mortgage insurance premium of up to 1.35% of the borrower’s outstanding balance on their loan, which is added to their monthly payment. Additionally, a fee of 1.75% is charged up front once the borrower closes on the loan.
For example, Newsday demonstrates exactly how the extra fees can add up: A borrower getting a $200,000 loan, after making a 3.5% down payment, pays $225 per month in FHA mortgage insurance, plus an upfront fee of $3,500. Say you keep that mortgage for 10 years before you sell or refinance -- that adds up to about $30,000 in mortgage insurance fees.
In some cases, an FHA loan is the best or only option, however loan experts urge consumers to examine all their options instead of making a knee jerk reaction by only applying for an FHA loan.
Conventional VS. FHA
Brian Gould, chief operating officer for mortgage insurer, United Guaranty says that borrowers almost always save money by choosing a conventional loan over FHA. "A conventional loan generally is less expensive for borrowers in almost all cases.”
An FHA backed loan is often sought because the buyer doesn’t have the recommended down payment needed to qualify for a conventional product, however, Katie Miller, vice president of mortgage products at Navy Federal Credit Union ($54 billion, Vienna VA) says that credit unions like hers have a number of viable options.
“Our HomeBuyers Choice product offers 100% financing, but without the mortgage insurance requirement. The product is a fixed rate, conventional loan that was designed to originally mirror our VA product.”
Miller explains that not everyone is eligible for a VA loan so the credit union created a product that provided wider opportunities for members to own a home.
“Plus, not having mortgage insurance to contend with is a huge benefit for our members,” she says. “Ever since the FHA raised the mortgage insurance premiums and no longer allow borrowers to eventually eliminate mortgage insurance, people are looking a little more closely at the alternatives.”
Miller says that the Navy Federal underwriting team carefully examines each application and makes good underwriting decisions that benefit both the member and the credit union. “We use risk based pricing so we are covered for risk without having to tack on all the insurance fees.”
Other Alternatives to FHA Loans
Miller also brought up a trend that used to be popular in the 1980’s that may possibly be making a comeback. Mortgage loan assumability is when the buyer assumes the seller’s mortgage. The buyer ends up paying less in closing cost fees, can skip the appraisal and can avoid monthly mortgage insurance premiums associated with an FHA loan.
“Many years ago, back when rates were at 18% or 20%, assumable mortgages were a little more prevalent,” she says. “As rates declined and remained low, assumable mortgages were no longer as popular.”
Although she’s only seen approximately 70 of this type of mortgage over the last year, assumable mortgages could have a stronger presence in the market as rates increase. “As rates continue to increase, mortgage assumption may become more of a viable option for buyers seeking alternatives to an FHA loan.”
“Also, borrowers have forgotten about the benefits an adjustable rate mortgage can provide,” Miller says. “For example, our 5/5 ARM product offers up to 100% financing and has a super low rate right now. What some borrowers don’t realize is that the product has a 2% cap that resets after five years. Using the current rate of 2.75%, the most the borrower could end up paying would be 4.75%, which is still a low rate.”
Miller adds that borrowers should also investigate special deals and promotions to secure additional discounts. “We have a rate match promotion where if the member can find a better deal in the market, they can bring it to us and we’ll match it. If we can’t match the offer we will give the member a $250 gift card. We also have a $2,500 closing cost promotion, so it’s important that the borrower looks into promotional offers and asks questions.”
Your local credit union lender can help! Ask for a full mortgage workup to identify the best deal for you.