Tuesday, May 10, 2011

FHA Modifies Loan Formula: Higher Mortgage Insurance Rates adds Cost to the Excellent, Low-Downpayment, Low-Credit Score FHA Loans

The Federal Housing Authority (FHA) periodically recalibrates the way it charges for the excellent, low-downpayment, low-credit score loans that it backs.  On April 18, the FHA increased the fees for mortgage insurance (MI), from .85% to 1.1% (for 5% downpayment or higher) and .9 to 1.15% (for downpayments less than 5%).  The one-time mortgage "points" (fees) that FHA charges for obtaining the loan is unchanged at 1.0% of the loan principal.

What is the monthly cost of owning a home purchased with an FHA loan?  Let's take the example of a $500,000 home purchased with a 3.5% downpayment.
  • Downpayment = 3.5% x $500,000 = $17,500
  • Mortgage points = 1.0% x $500,000 = $5,000
  • Closing costs = $3,000 (estimated, this could vary)
FHA allows the Buyer to roll the mortgage points and closing costs into the loan principal.  In this case, the loan principal is $482,500 (96.5% of the purchase price) + $5,000 + $3,000 = $490,500.  At today's interest rate of 4.875% (still near historical lows), the monthly mortgage payment is $2,596.

The monthly "nut" for this $500,000 home:
  • Principal and interest (P & I): $2,596/month (during the first year, about $615 of this is principal, the rest is interest; still, you are paying off $7,400 of the loan balance in the first year!)
  • Mortgage Insurance (MI): $470/month (calculated using the FHA rates)
  • Hazard (fire) insurance: $80 (estimated)
  • Property tax: $521/month (in Los Angeles county, this amounts to approx. 1.25% of home sale price, which is paid annually; this may vary due to differing tax levies in different areas)
  • Total: $3,667/month
Given the belt-tightening in Washington and the greater risk of default of these loans, they may one day (soon) go the way of the "no doc", "negative amortization" and "options ARM" loans.  Buyers should take advantage of buying opportunities in the market today, while this excellent buying "constellation" fueled by cheap government-backed money still exists.

Read the New York Times article about FHA loan rate changes.