Today we will assume that a young couple has applied for a mortgage to purchase their first home. The credit is acceptable, (not great and not poor) and the clients have expressed that they have saved ten thousand dollars for the down payment on a new home. Immediately it becomes obvious that the client will need a program that requires a very small down payment. This is where most mortgage professionals start advising clients into the wrong program. The first program that the mortgage professional tends to recommend is going to be FHA financing. It is the best option for first time home buyers with little money down and has an exceptionally low interest rate. It cant be a bad loan, it is backed by the federal government... Right? Wrong. In some sense the mortgage professional is right. With FHA financing the client is going to receive the lowest possible interest rate in the market and the lowest interest rate is, after all, easy to "sell". But what the client may not want to hear, and the mortgage professional may be afraid to express, is that a higher interest rate program is available with lower monthly payments and a lower overall effective cost. The loan is commonly known as conventional financing.
FHA financing has become extremely popular post mortgage
meltdown due to the lack of credit in private markets, but let's not forget what
FHA financing truly is. It is a loan backed by the federal government to serve
the under served. Far from the first choice for those trying to build
wealth. FHA offers a low interest rate and the federal government is able to
back ,or "guarantee" these loans through an insurance fund financed by
a combination of the up front Mortgage Insurance Premium and a monthly Mortgage
Insurance payment included in the monthly mortgage payment. Once the true cost
of the loan is calculated the ever popular FHA loan loses its flavor. The
current charge for the up front Mortgage Insurance Premium is currently 1.75%
of the loan amount. On a $200,000 mortgage, this is
equal to $3,500 up front in addition to the standard closing costs. That is a
lot of money that could be used in a more beneficial form to buy down the
interest rate on a conventional loan. I understand that some mortgage
professionals will say that the fee can be financed. How can it be an
issue, They say. I agree this does lower the dollar amount required from
the borrower, but a fee is a fee and if financed over 30 years with interest,
that fee becomes quite a bit more of a fee. In this example (Assuming 3.5% interest) the true cost of the MIP is $5,659.20. However, some clients just want to put as little money down as
possible. This is where the value of the mortgage professional should shine
through. Do not forget that we, as mortgage professionals, should be providing
sound financial advice, not the easiest sale.
The second "gotcha"
with an FHA mortgage is the monthly Mortgage Insurance requirement. The current
Mortgage Insurance calculation is 1.25% a year if the borrower were to put the
minimum 3.5% down. This is the most common scenario in FHA financing. On a $200,000 mortgage the Mortgage Insurance payment would be $208.33 in
addition to the monthly mortgage payment. And lastly, we add the invisible third cost; tax implications.
While mortgage interest is and should be tax deductible for the foreseeable
future, as of January 1st 2012, Mortgage Insurance is not. Because of this new
tax code, you will also pay more in annual taxes to the federal government if
you choose an FHA mortgage as your path to home ownership. That low interest rate might not seem so low anymore. Now, lets look closely at the second
option; Conventional Financing.
There is a common misconception that conventional
financing requires a 20% down payment and a credit report made of platinum and
Gold. While good credit is important, tighter lending guidelines have increased
the need for a reasonable credit score with an FHA application as well, and if
paired with a Private Monthly Mortgage Insurance Policy a down payment of only
5% is required. The difference between FHA's mortgage insurance and Private
mortgage insurance? Private mortgage insurance is part of the open market and
the competition from multiple MI companies drives down the cost compared
to the FHA loan option. Previously we stated that the monthly
Mortgage Insurance quote on a $200,000 FHA mortgage was approximately
$200 a month. If you decided on a Conventional Loan, the monthly Mortgage Insurance would be $98.33 a month.
Of course credit and other loan parameters do play into the insurance cost in a private market. The difference between the FHA and Conventional Mortgage Insurance is $101.67 a
month. If you choose a conventional loan, slightly more money will be needed
down as the maximum LTV (Loan to Value) is 95% vs 96.5% for FHA. That is 1.5 % Additional needed as a down payment, However, you are not financing the 1.75% required by FHA.
Which do you think is best..paying an extra 1.75% as a fee financed with
interest, or paying down your mortgage 1.5% to lower your loan amount and
overall effective cost? Easy answer I know. Yet loan officers across the country still recommend FHA for
the lower interest rate. So what does HUD do with all this money you ask?? Pay banks the lost money on forclosed FHA mortgages.
So how much higher is the interest rate on a conventional mortgage?
Roughly .375% higher. To help put this into perspective, have a look at the
numbers below.
FHA
Loan Amount - $200,000 Mortgage Pmt -$898.09 PMI Pmt -$208.33 Total Pmt - $1106.42
Conventional
Loan Amount - $200,000 Mortgage Pmt - $940.97 MI Pmt - $98.33 Total Pmt - $1039.30
The total difference between the two mortgage options is $67.12 or $24,163.20 over the life of the mortgage
Monthly Mortgage Insurance does not last forever. FHA MIP is canceled when the LTV reaches 78% and on Conventional Loans, 80% no matter how long you have
paid monthly mortgage insurance. At the point of Mortgage Insurance elimination; the FHA mortgage does prevail due to the lower
interest rate. But here is the catch; Because interest is front loaded on a
mortgage, the 78% marker is typically not reached until the 10th yr of paying on a mortgage.
In summary; every individual client will have their individual needs but the most popular loan option does not always reflect the best option for you. While discussing loal with your mortgage professional, be sure to ask about Conventional financing and how it compares to the more popular Government backed loan programs. For more information or to contact me directly, please visit www.plattsburghmortgage.com
Travis Carter
Sr Mortgage Consultant
Bridgeview Bank Mortgage Company
In summary; every individual client will have their individual needs but the most popular loan option does not always reflect the best option for you. While discussing loal with your mortgage professional, be sure to ask about Conventional financing and how it compares to the more popular Government backed loan programs. For more information or to contact me directly, please visit www.plattsburghmortgage.com
Travis Carter
Sr Mortgage Consultant
Bridgeview Bank Mortgage Company
