Mortgage Q&A: FHA loan best deal for many

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The demise of subprime, no-documentation and no-down-payment loans is more than three years past. Many folks with less-than-perfect credit and little cash have turned to Federal Housing Administration (FHA) and Veterans Affairs (VA) loans for their home financing needs.

I’d like to use this week’s column to summarize the features of FHA loan products. While the FHA has recently tightened its standards, it’s the only game in town for a low down payment. Consider the following:

  • FHA loans require just a 3.50 percent down payment in most areas.
  • Maximum allowable loan amounts vary from $271,050 to $793,750, depending upon the area.
  • Interest rates are competitive. Today’s 30-year fixed rates are as low as 4.50 percent with no points or origination fees.
  • 3/1 and 5/1 adjustable-rate mortgages are available.
  • Most lenders will accept FHA applicants with credit scores as low as 620.
  • The FHA allows gift funds for 100 percent of the down payment from a family member. It also allows the seller to contribute up to 6 percent toward the buyer’s closing costs.

The downside to an FHA loan is the mortgage insurance premium, or MIP. FHA applicants must pay MIP in two ways: first, an upfront fee of 1 percent of the loan amount, which can be financed into the loan, and second, an additional annual premium of 1.10 percent to 1.15 percent, depending on the down payment, added to the mortgage payment.

Such premiums are not as expensive as one might think, and if an FHA loan is the only option, it’s well worth it.

Let’s look at the example of a $300,000 purchase. The down payment would be 3.50 percent, or $10,500. The loan amount would be $289,500 plus the 1 percent upfront MIP premium of $2,895, totaling $292,395.

At 4.50 percent, the monthly principal and interest payment (P&I) equals $1,482. Add the annual 1.15 percent premium of monthly $277 payments, and the total monthly payment, excluding hazard insurance and real estate taxes, equals $1,759.

Factoring in the monthly MIP bumps the “real” interest rate to about 6.125 percent. Still, for folks with less-than-perfect credit and low cash, it’s not a bad deal.

If you have an existing FHA loan, a streamline refinance might be worth considering. Features of an FHA streamline refinance include:

  • No appraisal is required if the new loan amount doesn’t exceed the existing loan balance. This is a fantastic feature at a time when many property values have dropped, prohibiting many homeowners with conventional programs from refinancing to today’s low rates.
  • Closing costs can be rolled into the interest rate, allowing the borrower to pay no closing costs out of pocket. It also allows the borrower to keep his loan amount the same, which in turn allows for a no-appraisal refinance. With no fees, 30-year fixed-rate FHA streamline products are under 5 percent.
  • A minimum credit score for a streamline refi is just 640.

There you have it, folks. If you’re a looking to buy and are hoping for a low cash outlay, an FHA loan is worth investigating. Alternatively, if you are an existing homeowner with an FHA loan and think you are ineligible for a refinance, think again.

Next week, we’ll cover VA loans.

Send email to henrysavage@pmcmortgage.com.

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