The lending landscape shifted measurably this month when the standard-bearer for first-time buyers and low-to-moderate income borrowers became more expensive than its private business counterpart.
On April 1, fees for low-down-payment mortgages insured by the Federal Housing Administrationrose for the third time in two years. The hike in fees serves a twofold purpose: to help shore up the FHA’s sagging mortgage insurance fund, which is dangerously low; and to reduce the government’s footprint in the mortgage market.
Only time will tell whether the first objective will be reached. But the second goal — allowing private mortgage insurance companies to gain a larger market share — probably will be met because PMI is now the less expensive alternative.
How much less expensive? Over a five-year period, borrowers with a 760 FICO score who make a 5% down payment on a 30-year, $170,000 mortgage could save more than $4,000 by opting for a loan insured by Genworth Financial, one of six private mortgage insurers.
Of course, most folks don’t have credit scores that high. But for nearly all borrowers who can come up with a down payment of at least 3.5% on a loan of up to $625,000, PMI is now probably the better deal.
The FHA has always been the first choice of borrowers with low down payments who couldn’t meet the private sector’s more rigid underwriting standards. And during the housing debacle, the agency picked up the slack as private insurers backed out of the market. A couple of companies even went out of business altogether.
But the FHA paid dearly for its efforts in supporting the market. Foreclosures are up significantly, and the health of the insurance fund from which claims are paid is at or below the level required by Congress.
So, as of April 1, the agency raised its annual premium by 0.05 percentage point to 0.1%, depending on the loan amount and the all-important loan-to-value ratio. That’s on top of an earlier 0.1 percentage point increase in the annual fee instituted last April, as well as the hike in the upfront mortgage insurance premium, to 1.75% of the loan amount from 1%.
As a result, the choice between mortgages with private mortgage insurance and those insured by Uncle Sam has never been clearer.
Lenders require insurance, either private or government-based, on mortgages in which there is a down payment of less than 20%. Such loans are considered more likely to default than those in which borrowers have more of their own money on the line.
Here’s how a 30-year, $170,000 FHA-insured loan with 5% down compares with one insured by Genworth.
The interest rate on the FHA loan is 4%, but because of secondary market fees charged on conventional loans, the rate on the Genworth-backed loan is 4.375%. Even though the privately insured mortgage carries a higher rate, it is still cheaper because the FHA’s insurance fees are higher.
First, there’s the 1.75% upfront mortgage insurance premium. In this case, that amounts to $2,975, bringing the total loan amount to $172,975. Then there’s the 1.3% monthly premium, which adds $184.17 to the monthly mortgage payment, bringing your total monthly payout to $1,009.98.
Genworth, on the other hand, isn’t charging an upfront premium, so the loan amount remains at $170,000. Moreover, its monthly premium is just 0.59%, or $83.58. So the total monthly payment is $932.37, a difference of $77.61 a month. Over a five-year period, the savings is $4,656.60.
Now look at the same loan with 10% down.
Again, the coupon rate is somewhat higher on the Genworth-insured loan because of the secondary market charges. But the company wants no upfront fee, whereas Uncle Sam wants 1.75% at closing. Thus, just as with the 5% down scenario, you are borrowing $172,975 with an FHA-insured loan versus $170,000 otherwise.
The other big difference is the monthly mortgage insurance premium: the FHA’s 1.3%, or $184.17, versus Genworth’s 0.44%, or $62.33.
In total, then, the monthly payment would be $1,009.98 on the government mortgage as opposed to $911.12 for the privately insured loan. Over a five-year period, the savings on this 10% down mortgage is $5,931.60.
Another advantage a privately insured loan has over one backed by the government is that PMI can be canceled. And in a market in which housing values are rising, this is an extra added benefit on top of lower monthly costs.
Currently, the FHA will allow borrowers to cancel coverage once their loan-to-value ratio reaches 78% of the original loan balance. But starting June 3, the government will require borrowers to pay the premium as long as the loan is in force. In other words, the only way the insurance can be ended is by refinancing or otherwise paying off the loan.
On the other hand, PMI can be canceled at the borrower’s request when his equity reaches 20% — as long as he is current on his payments and the value is backed by a new appraisal. Termination is automatic when the loan amortizes to a 78% loan-to-value ratio — again, as long as you are current.