Tuesday, January 20, 2015

FHA Mortgage Insurance Rate Reduction - what does it really mean?

Earlier this month President Obama visited Phoenix, giving a speech from Central High School in which he outlined an upcoming 0.5% reduction of the FHA Mortgage Insurance rates. But what exactly does this mean?

President Obama lands in Phoenix, AZ
image credit:

First of all, let's talk for a minute about FHA loans. FHA loans:

  • require a very small down payment of 3.5% of the purchase price.
  • allow ALL other money to come from a gift &/or seller concession, which means if a buyer can save up for a 3.5% down payment and can qualify for the monthly payments, he/she can buy a house.
  • allow for slightly easier credit scoring criteria than conventional loans.

Now, if you make the argument that owning a home is beneficial (and I would, especially over the long term), and FHA helps people buy a home who otherwise wouldn't be able to buy a home, then it stands to reason that FHA loans are a good thing. However, FHA loans are rather expensive when compared to the conventional FNMA counterparts - since low down payments and lower credit scores are more risky loans, they cost a little more, and this cost comes in the form of mortgage insurance.

FHA loans charge 2 different types of mortgage insurance:

Up Front Mortgage Insurance Premiums (MIP) - the lender will calculate a percentage of your loan balance and add it back into the FHA loan, giving a new, higher balance, upon which the payments are calculated. This premium is usually, but not always, non-refundable.

Monthly Mortgage Insurance (MMI) - each year the lender will calculate a percentage of the current outstanding loan balance, and spread this premium out over the next 12 monthly payments. This premium will decrease over time as the loan balance is reduced.

For comparison, conventional FNMA loans only charge the monthly type of mortgage insurance, called Private Mortgage Insurance (PMI), and the rate used to calculate the premium is usually lower than the FHA's rate.

Going back to President Obama and the new lower rates, let's take a look at the FHA's recent mortgage insurance rates (click chart for full size):

FHA Mortgage Insurance Rate Changes, assuming 3.5% down payment and 30 year term

Historical FHA Mortgage Insurance Rate Chart

I look at that chart and see two things that jump off the page at me:

  1. Rates are still way up compared to historical measures - yes, they're giving a 0.5% reduction this month, but they're still almost double what they were for many decades prior to 2008.
  2. MMI never goes away - yes, the annual premium (and corresponding monthly payments) will decline over time as the loan balance declines, but they never go away. You're stuck paying mortgage insurance for as long as you have that mortgage - 10 years, 20 years, 29 years.. That's absurd.

So what does all this mean?

Well, FHA rates will be lower this year than they were last year. And if an FHA loan is the only way you can buy a house, then it's an option probably worth considering. You'll have to pay mortgage insurance for long after it should be required, but that just might be the cost of home ownership (which includes pride/stability, equity, fixed payments, and eventually no housing payment.) However, if you can find a way to squeeze into a conventional FNMA loan, that would be a much better option.

You might also want to keep one eye on interest rates, so you can refinance to a conventional loan once that's an option. I wrote about the benefits of doing so on my Rags To Recovery website just last week.

You're probably going to be hearing more about the FHA insurance premium reduction in the coming weeks; hopefully this helps put it into perspective..

- Chris Butterworth