- - Thursday, May 12, 2011

Borrowers seeking Federal Housing Administration loans will soon feel the pinch, as mortgage insurance premiums on FHA loans have been increased along with borrowers’ credit-score requirements.

In recent years, borrowers have relied more and more on FHA loans for two reasons. First, these federally insured loans require a down payment of just 3.5 percent of the loan amount, compared with a conventional loan requirement of a 5 percent to 20 percent down payment. Second, FHA loans, because they are insured by the government, generally have looser credit requirements than conventional loans.

In 2010, more than 30 percent of all home-purchase mortgages were FHA-insured, compared with less than 6 percent in 2005. Before 2008, when the mortgage crisis began, homebuyers found it far easier to qualify for a home loan, and lenders were offering loans without requiring any down payment. Since that time, FHA loans have been among the only mortgage products (other than Veterans Affairs and Department of Agriculture loans, which also are federally insured) available to homebuyers who don’t have enough cash for a larger down payment.

Congress mandates that the FHA have enough capital reserves to cover losses incurred on the mortgages it insures. The reserves come from insurance premiums charged to FHA borrowers. As FHA reserves have dipped, the agency has taken steps to tighten loan requirements and increase its assets.

In 2010, FHA began requiring a minimum credit score of 500 and also requiring borrowers with a credit score of 500 to 579 to make a down payment of at least 10 percent.

All FHA borrowers are required to pay an annual mortgage insurance premium as well as an upfront mortgage insurance premium. The upfront mortgage insurance premium is 1 percent of the loan amount. Beginning April 18, the annual mortgage premium, which is paid along with the monthly mortgage payments for principal, interest, taxes and homeowners insurance, was raised by 0.25 percent on all 15- and 30-year loans.

The new premiums apply only to new loans and mortgage refinances, not to existing FHA loans or reverse mortgages. According to the FHA, the average new FHA borrower will pay approximately $33 more per month for a mortgage of $157,000.

Doug Benner, a senior loan officer with Embrace Home Loans in Rockville, said, “In real dollars, this increase will cost about $20 more per month for every $100,000 borrowed. Homebuyers who borrow $300,000 would pay about $60 more for the higher insurance premiums.”

Mr. Benner said the higher mortgage insurance premiums may encourage more borrowers to apply for conventional loans as long as they have the minimum down payment of 5 percent of the purchase price.

“If you are a first-time buyer without enough money for a bigger down payment, or if you don’t have great credit, an FHA may be the only avenue for a loan approval,” Mr. Benner said. “If you have a little more cash and a credit score of 700 or above, a conventional loan could be the better option.”

Mr. Benner said FHA mortgage insurance premiums are not negotiable and cannot be paid in advance, so the payments must be included in the debt-to-income ratio that is part of the loan-approval process.

“While the increase in insurance premiums will not necessarily be a problem for most people, it could impact 1 [percent] or 2 percent of FHA loan applicants who are on the edge of qualifying,” said Johnathan Thomas, vice president of mortgage lending for Virginia Commerce Bank in Chantilly.

Mr. Thomas said changes to the FHA program should lead borrowers to consider conventional financing.

“Every lender has a different set of qualifications for borrowers, but many are offering 95 percent loan-to-value mortgages for borrowers with credit scores of 720 and above,” Mr. Thomas said. “We like to see borrowers for this type of loan have six months of mortgage payments in a liquid asset so that the risk of default is lower.”

Mr. Benner said lenders are beginning to make more 95 percent loan-to-value mortgage approvals than they were last year, which means borrowers can either pay private mortgage insurance or wrap that cost into a higher interest rate.

“Another option that we are beginning to offer again is the 80-10-10 loan, which allows borrowers to make a 10 percent down payment and then split the mortgage into two loans to avoid paying private mortgage insurance,” Mr. Benner said. “These loans are available to people with good credit and with a maximum overall debt-to-income ratio of 45 percent or possibly 50 percent in some cases.”

At Navy Federal Credit Union in Vienna, Barbara Sheehan, assistant vice president for mortgage products, said the credit union has alternatives to FHA loans that may work better for some borrowers.

“Our Choice Program is a zero-down-payment loan program that requires an upfront funding fee of 1 percent with no monthly mortgage insurance,” Ms. Sheehan said. “The credit terms are not as broad as FHA, but these loans are available for people with A and B credit ratings. We also offer VA loans with zero-down-payment requirements. Both of these programs require thorough documentation, and we look at the income and assets and how well the borrowers have paid their bills in the past. With good underwriting, these programs are very successful.”

More mortgage applicants may turn to alternatives to FHA financing if some of the other potential changes to the program are put in place. There has been some discussion about raising the minimum down payment for FHA loans to 5 percent, although this has yet to be approved.

Another possibility is that seller contributions for closing costs, currently allowed for up to 6 percent of the sales price, would be limited to 3 percent, which is standard for conventional loans. Some real estate experts anticipate a flexible approach to seller contributions, allowing from 3 percent to 5 percent of the sales price, depending on the loan amount.

The Obama administration has recommended that the conforming-loan limits for FHA, Fannie Mae and Freddie Mac loans be returned to the traditionally lower limits as of Oct. 1, 2011. For the Washington area, conforming-loan limits would be set at $625,500 rather than the current $729,750. Borrowers above the limit need a jumbo loan, which carries a higher interest rate and sometimes higher credit requirements.

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