If you are a first-time home-buyer, chances are you may wind up with an FHA loan (or VA loan if you're a vet - but that's another story). FHA loans have some really good features and are a great way to finance the purchase of a home. However, conventional loans offer some good options for those who can qualify. In order to provide you with a baseline, I will give you the elements of FHA - good and bad - so that you can compare the many options with the conventional loans and the mortgage insurance options they offer.
FHA: One size fits all. FHA guidelines are a little more lenient when it comes to credit issues and employment. They are a bit stricter under their newly issued underwriting guidelines - the 4000.1 (the old 4155 is no longer in use). Medical collections are still a non-factor, which is a good thing. Additionally, debts that belong with assets assigned to an ex-spouse in a divorce decree also won't kill a deal if the ex-spouse decided to let the family home or car go - your credit score will definitely take a hit and you may have to pay a higher interest rate but you might still be able to get a loan. On the mortgage insurance side of things, FHA has two elements, an up front mortgage insurance which is typically 1.75% of the base loan amount and is financed into the loan 99.99% of the time (I've had one client pay the UFMIP in cash in my 20+ years of doing mortgages). The other part is the Annual MIP which is .85% of the base loan amount and it's paid monthly (.85% x base loan amount divided by 12). FHA requires a 3.5% down payment which can come from a gift and rates are typically about .25% lower than conventional loans - usually, but not always. The rates on FHA loans are not impacted by credit scores as much as conventional loans either but the higher the credit score you have, the better the rate is. Finally, as alluded to above, FHA loans can be approved with lower credit scores, even down to the low 500s.
Conventional loans - more choices, more solutions. Now that we have a baseline against which to compare, let's take a look at conventional loans and then we'll get to the heart of the matter, private mortgage insurance. Conventional loans have many options for a wide variety of borrowers.
The My Community program is conventional's response to FHA and allows a borrower to finance 97% of the purchase price of a home. With a 3% down payment requirement and no required up-front mortgage insurance, out-of-pocket expenses can be lower while also having a lower loan amount. As mentioned previously, credit scores are much more important when it comes to getting the best interest rate AND the best mortgage insurance premium. On this program, a credit score of 660 yields a mortgage insurance rate of .94% (9 basis points higher than FHA's) while a credit score of 700 yields a rate of .80% - 5 basis points lower than FHA's. A 720 credit score gets a borrower a rate of .60% - a full .25% lower than FHA which roughly offsets the difference in interest rate. Some of the difference is already offset by not having to finance the UFMIP. Additionally, FHA requires borrowers to keep the mortgage insurance for 11 years regardless of the amount of equity where as conventional loans (including the My Community program) allow borrowers to get rid of mortgage insurance when they have paid down their balance to 80% of the purchase price regardless of how long they've had their mortgage (typically there is a two year mandate but most loans won't hit the 80% level until 5-7 years or more, depending on whether a borrower has made extra payments. Additionally, mortgage servicers are required to cancel the mortgage insurance when the balance reaches 78% of the original purchase price.
Other conventional options include loans of 95%, 90%, 85% and 80% (or less) of the purchase price. Each step down in loan amount (loan-to-value) yields a lower mortgage insurance premium for a given credit score. Larger down payments mean lenders have lower risk which means mortgage insurers have lower risks which is why they can offer lower premiums. With a 20% down payment, mortgage insurance is not required and since your loan amount will be lower, this is where you will have the lowest monthly payment since you will also get a better interest rate for a given credit score; hence, a convolution of three things - smaller loan, no mortgage insurance and better interest rate - provide the lowest monthly payment. Since most people don't have the ability to put 20% down on their home, let's look at some mortgage insurance options that most people don't know about.
Unlike FHA which has UFMIP and one annual rate for the biggest majority of their borrowers, conventional loans offer a plethora of mortgage insurance options including, BPMI (borrower paid mortgage insurance), LPMI (lender paid mortgage insurance), Single-pay (which can either be paid by the borrower or the lender) and Split premium. Additionally, these options have a choice of refundable (more expensive) or non-refundable (less-expensive).
Borrower Paid Mortgage Insurance: This option is the most common one and may be the only one that most loan officers know about and offer to their clients. With this option, the borrower pays a monthly mortgage insurance premium based on the percentage of the loan relative to the purchase price (loan-to-value) which means a $200,000 purchase price with 5% down is a 95% loan to value ($190,000 loan amount), the borrower's credit score and the minimum required coverage (this is a number derived from the automated underwriting systems - the better the credit score, the lower the coverage requirement and the better the mortgage insurance premium rate. This mortgage insurance can be canceled when the borrower pays down the mortgage to 80% and requests cancellation from the lender and it has to be cancelled when the balance reaches 78% - this is a big advantage over FHA if the borrower is going to be in the home long enough to take advantage of this.
Lender Paid Mortgage Insurance: This option has it's good and it's bad points. Unlike the BPMI, lender paid mortgage insurance can never be cancelled so if you plan on being in the home for a long time (7+ years, give or take), then this is not the most cost-effective option. Instead of having a separate mortgage insurance component in your monthly payment, the lender pays for it through a higher interest rate. The premium rate depends on coverage and credit score but it's typically between .375% and .75%. The advantages of this option are a lower mortgage payment compared to BPMI and a larger tax deduction since the borrower is paying more interest (consult a tax advisor for specific questions regarding tax deductibility). For borrowers who are confident that they won't be in the home for a long time, this is a good option.
Single-pay Mortgage Insurance: While it is very rare that a borrower will choose this option, it is a great option for those who can afford to do it. A borrower with a 720 credit score who is putting 3% down on a My Community program would have a one-time premium of 2.18% ($4,360 on a $200,000 loan) and would not have a mortgage insurance payment which saves $100 per month for a borrower with the same credit score who opts for the monthly BPMI. The up-front premium can be paid out of the borrower's savings or by a gift from a family member. With a lower payment, the borrower can either qualify for a more expensive home or have a little more breathing room at the end of each month. The up-front premium can either be refundable or non-refundable with the non-refundable being the most common and least expensive option. For comparison purposes, a borrower with a 660 credit score would have a single-pay premium of 3.68% ($7,360) or their monthly premium would be $156.67; this really drives home the emphasis that conventional guidelines places on good credit scores.
Split-Premium Mortgage Insurance: This option is similar to what FHA does and offers borrowers the flexibility to have a a lower monthly mortgage insurance premium by paying a portion of the premium up-front. The borrower has a wide variety of options when it comes to a split premium since they can virtually say how much they want to pay up-front and then the monthly premium is calculated on what's left. For a borrower with a 720 credit score who can pay 1% of the loan amount in mortgage insurance premium up front, the monthly premium would be .32% ($53.33). An up front premium of .5% ($1,000) would yield a monthly premium of .45% or $75. If you compare this with an FHA loan which would have an up-front premium of 1.75% ($3,500) and a monthly mortgage insurance payment of $141.67, you can see how much better the conventional option is for buyers with a good credit score. The same scenario for a borrower with a 660 credit score would yield a monthly mortgage insurance payment of $131.67 (.79%) with an up-front premium of 1%.
As you can see, conventional mortgage insurance provides lots of options to help a borrower qualify for a mortgage based on their specific scenario. Call me at 702-812-1214 or 801-853-8720 to find out what financing scenario is best for you or your client. Please feel free to leave your thoughts and ideas in the comments section. You can also email me with questions at jed.wunderli@noblehomeloans.com.
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