Is an FHA loan still the best option for home buyers with a low down payment?
Down payment is the most important concern for many first time home buyers with moderate incomes and limited savings. Finding a low-down payment mortgage loan with flexible requirements can be your gateway to homeownership.
Before the financial crisis of 2008, there was an abundance of loan programs offering home financing with minimal down payment requirements. In fact, many mortgage lenders at that time were not only providing 100% financing, they were also allowing for the additional closing costs be included in the loan amount. Those days are long gone, and the current home lending environment is diametrically different.
For home buyers looking to buy their first home with very little down payment, the preferred option has always been the loans insured by the Federal Housing Administration (FHA). Most of the FHA loans for home buyers required a down payment of just 3.5%. Additionally, they allow for flexible guidelines that make loan eligibility for borrowers with spotty credit histories and limited assets.
As most of the conventional lenders pulled back from financing limited down payment borrowers, FHA stepped up to fill the void. The rapid rise in the number of borrowers taking advantage of the FHA loan programs in the past five years is a testament to that shift. That may be about to change due to the series of increases made to the FHA mortgage insurance premium requirements.
The biggest change in regards to the recent FHA MIP changes is the introduction of a new rule that does not allow for the cancellation of annual insurance premium for the life of the loan. The move has been controversial, and it is expected to have a significant impact on the number of home buyers opting for FHA financing. These recent changes are also expected to favorably impact Fannie Mae and its small competitor, Freddie Mac.
FHA’s lower interest rates may not matter much
Traditionally, the FHA interest rates have been lower than those offered on conventional loans. This rate advantage may no longer be relevant due to the premium increases. Consider a typical loan scenario:
Suppose you want to buy a new home with a sale price of $200,000. If you opt for an FHA-insured loan, you need to come up with 3.5% down payment, which amounts to $7,000.
Fannie Mae’s “My Community Mortgage” program is similar to the FHA low down payment loan. In fact, it requires an even lower down payment of just 3%. If you were to opt for this your down payment will be $6,000.
PMI Makes a Difference
For FHA loans, the borrower will need to pay 1.75% as upfront mortgage insurance payment; this amount may be financed into the loan amount. Suppose, the borrower opts to do so, now the total loan amount would be $196,500 ($193,000 + 3,500).
After the new changes, the annual PMI will be 1.35% for borrowers opting for a 30 year fixed rate loan with an LTV above 95%.
With the Fannie Mae “My community Program,” the PMI will be at 18% coverage for 97% LTV. While the rate on Fannie Mae loan will be higher, the difference in PMI payment will be more than sufficient.
Moreover, the PMI can be cancelled after the LTV reaches 80%, while on FHA loans, you’ll have to pay for the life of the loan.
The qualification guidelines for Fannie Mae loans are much stringent. You would need a credit score above 680, whereas it can be as low as 580 with FHA loans. To be eligible for Fannie Mae “My Community Mortgage” program, your income should not exceed the median income of your area to be eligible, while no such restrictions apply for FHA loan programs.
Basically, if you do have good credit and low income, the best option would be the Fannie Mae low down payment program due to lower lifetime cost of financing. If you have a lower credit score and have little to put towards down payment, your only option is a FHA loan, unless you are eligible for USDA loans or VA loans.