Even though we’re only three weeks into the New Year, 2015 has treated the mortgage industry well. Very well…
Mortgage applications have surged week after week, propelled mostly by refinancing as borrowers take advantage of the low mortgage rates currently available.
And beginning next week, the FHA should get a huge boost as borrowers take advantage of the 50 basis point cut in annual mortgage insurance premiums.
While some may not be all that moved by the premium reduction, the Urban Institute believes it’s enough to make FHA loans cheaper than conventional loans in pretty much every scenario.
50 Basis Points Makes a Difference?
Yep, those 50 basis points could be enough to sway your home loan decision.
Prior to the change, which is scheduled to take effect next Monday January 26th, the average mortgage payment for an FHA loan on a $250,000 home with 3.5% down comes in at roughly $1,443.
Once the annual mortgage insurance premium is cut to 0.85% from 1.35%, the monthly payment for the same scenario drops to $1,343.
As a result, FHA financing becomes the cheaper option relative to conventional lending, especially for someone with a low FICO score.
Just take a look at the chart above. As you can see, the old premium structure meant conventional lending was cheaper if a borrower had a 720 FICO score or higher, which many do.
Come next week, FHA will be cheaper no matter what your FICO score. Now keep in mind that this assumes a mortgage rate of 4% from the FHA and 4.5% to 5% when going the conventional route.
So results may vary depending upon interest rate, but it does illustrate how powerful a seemingly simple insurance premium reduction can be.
It’s no wonder the Obama Administration expects the change to result in 250,000 more first-time home buyers over the next three years.
And the annual average savings of $900 could benefit more than three million FHA borrowers looking to refinance their existing mortgages.
Interestingly, the move should actually benefit the FHA despite some calling it risky. Why? Because borrowers with higher FICO scores may turn to the FHA again to save money.
That means the FHA won’t just draw the low-FICO score crowd anymore. So despite bringing in lower premiums, they actually get a better borrower and risk goes down.
Additionally, borrowers with lower mortgage payments should present lower default risk, which again benefits the FHA.
Perhaps less obvious is the fact that the FHA premium cut could benefit conventional loan borrowers as well.
If private mortgage insurers see that more borrowers are turning to the FHA, they might have to reduce premiums themselves to drum up business and compete.
In other words, all borrowers may benefit from the changes at the FHA, even if they don’t take out an FHA loan.
It’s Not Totally Apples-to-Apples
I should point out that the FHA isn’t a slam-dunk option for all borrowers. For one, the loan limits on FHA loans might not be high enough for some borrowers with little to put down.
At the same time, the minimum down payment is 3.5% at the FHA. Conventional lenders now allow financing up to 97% LTV, or just 3% down. It can make a difference.
Another downside to the FHA is that mortgage insurance is generally a life-of-the-loan concern nowadays, assuming you put down very little and go with a 30-year loan.
For conventional loans, PMI can be dropped at 80% LTV, so there are potential savings for a homeowner who sticks with their loan long-term.
But one could argue that most borrowers don’t keep their mortgages very long, often less than 10 years, so that makes the FHA loan choice even more compelling.