At the time of this posting we are just a few days from July 4 and celebrating Independence Day. So why do I feel like I’m Bill Murray in the movie Groundhog Day?
If you’ve never seen it, Bill Murray plays a weatherman who wakes up each morning to find he is living the same day — Groundhog Day — over and over again.
I too feel trapped in a never-ending cycle after reading yet another article about first-time homebuyers with a familiar spin on it.
This time it was a Campbell Survey from research director Tom Popik. He suggests that FHA is the answer for first-time homebuyers, and that FHA premium changes are responsible for the recent surge of first-time homeowners.
To be fair, he is not the only person to draw that connection. It seems every month or so an article pops up touting FHA as the solution for first-time homebuyers. Which would be okay if FHA were positioned as a solution, instead of the solution.
Conventional vs. FHA
I don’t like using the term “vs.” when talking about conventional lending and FHA. I really don’t consider them to be pitted against one another. To me, they both serve as choices for homebuyers, particularly first-time homebuyers who are looking to achieve the goal of buying a home.
However, because first-time homebuyer mortgages are a substantial percentage of the loans we insure, and because so many articles seem to focus only on FHA as the solution for first-time homebuyers, I feel compelled to point out some reasons why a first-time homebuyer should think conventional when buying that first home.
Less money down
FHA requires a minimum of 3.5% down. However, both Fannie Mae and Freddie Mac offer borrowers the option of putting just 3% down. While 0.5% might not seem like much, it adds up to $1,000 on a $200,000 purchase that the homebuyer doesn’t need to come up with or can keep in savings. Or, the homebuyer can use that money to buy appliances and furniture instead of taking on more debt.
FHA requires an upfront payment of 1.75%. Most often this amount is financed into the loan, because let’s face it — if borrowers had the money to pay the upfront premium, they would use it to get to 95% LTV. Financing the premium into the loan means borrowers are sacrificing equity and, in a way, giving back half of the down payment they worked so hard to save.
Conventional lending with private mortgage insurance offers a variety of premium plans to choose from. The most common is Monthly mortgage insurance, which features no upfront premium and no additional closing costs.
While many articles point out that the recent FHA reduction in premiums is great for consumers, they don’t mention that those first-time homebuyers are going to be paying that premium for the life of the loan, unless they put at least 10% down.
Not only is private mortgage insurance automatically cancelled based on the original value of the home, but also, both Fannie Mae and Freddie Mac allow a new appraised value to be used to support a borrower-requested cancellation of mortgage insurance.
And even in situations where an FHA loan can provide the borrower a lower initial monthly payment than a conventional loan, it might still make more sense for the borrower to go conventional, especially when you consider that FHA requires a larger down payment and an upfront premium. Despite the initial lower monthly costs FHA can offer, private mortgage insurance can often be cancelled before the borrower would reach the break-even point.
Credit scores and DTI
FHA does offer some benefits over conventional lending for certain borrowers. FHA accepts lower credit scores and higher debt-to-income (DTI) ratios, although this can be misleading too.
MGIC insures loans down to a 620 credit score. Fannie Mae and Freddie Mac currently have a QM exception to DTI, and MGIC allows you to follow your DU Findings or LP Feedback for DTI requirements.
That said, a borrower with a low credit score and higher debt obligations may be better off going with an FHA loan. Again, I don’t see conventional lending and FHA competing against one another as much as offering borrowers different solutions.
I am waiting for the media to present both conventional lending and FHA as solutions for first-time homebuyers, instead of focusing on one and leaving the other in the shadows. Then I can finally escape this “Groundhog Day” — and that would be cause for celebration.Tags: FHA, Mortgage Industry, Mortgage Insurance