The new mortgage guidelines that took effect this week may make it easier for consumers to qualify for loans – which should help a stagnant housing market. But the changes may also shake up the landscape for homeowners putting down less than 20%.
No doubt the new rules bring with them some benefits. They should speed up the loan process and reassure lenders that the loans they are offering meet guidelines. They also provide some flexibility when it comes to down payments.
That flexibility disappeared in the wake of the housing crisis as lenders tightened requirements – demanding larger down payments and higher credit scores from applicants.
Private mortgage insurance
One reason buyers had to come up with more money for a down payment was the lack of private mortgage insurance (PMI). When a borrower makes less than a 20% down payment they are required to take out PMI to cover the loan in case of default. Because there were so many defaults after 2008 many mortgage insurance companies went out of business. Survivors became a lot more choosy about who they would cover.
FHA loans quickly became the low-down-payment option for consumers, and FHA loan volume surged 355% from 2007 to 2009. So did their fees.
Now that new mortgage rules are in place, consumers have options. Some conventional loans are requiring as little as 3% down, but also requiring the borrower to take out PMI. The premium is paid monthly, as part of the mortgage payment.
So the question would-be buyers with small down payments face is, FHA or conventional? With rising costs for an FHA loan, is a conventional loan with PMI a better option?
Personal finance website WalletHub has analyzed the new rules and has concluded that a home buyer can bank significant savings on mortgage insurance by choosing a conventional loan over an FHA loan.
The reason is simple. The study found that FHA mortgage insurance premiums have nearly doubled since 2008. Someone who buys a median-priced home now has to pay $17,398 in premiums during the first 5 years, compared to just $9,210 in 2008.
By going with a conventional loan consumers putting less than 20% down can save between $2,251 and $12,026 in just 5 years. The higher the down payment, the lower the premiums.
The study identified another money-saving advantage of a conventional loan. An FHA loan, which is guaranteed by the U.S. government, requires a mortgage insurance payment for the life of the loan.
But with a low down payment conventional loan, the homeowner may be able to stop PMI payments once they achieve at least 22% equity in the property. That can reduce monthly mortgage payments by more than $100.
The study uncovered another interesting finding. At present there is little use in shopping around since the 4 largest PMI companies charge virtually the same thing for a policy.
What to do
If you want to purchase a home and have less than 20% down, it is a good idea to talk to a mortgage company about both options – and FHA or conventional loan – and compare the costs.
WalletHub points out that most lenders usually go with one PMI company so to compare policies it may be necessary to talk to several lenders. When comparing FHA and private mortgage insurance costs, be sure to include FHA’s up-front mortgage insurance cost that is typically financed into the loan amount.
Finally, make sure you are aware of all costs of any loan you are considering. When you compare FHA and private mortgage insurance costs, include FHA’s up-front mortgage insurance cost that is almost always financed into the loan amount.