Yes, but why in the world did you take out an FHA-insured loan when you were able
to make a 20% down payment?
"We were inexperienced first-time buyers, so we went with the lender
recommended by the builder. The loan officer advised us that FHA is secure because
it is a government loan."
The loan officer probably took advantage of you. I can't say for sure because
I don't have all the loan details, but the loan officer's reason for selecting
an FHA loan makes no sense.
FHA loans are for borrowers who seek loans no larger than the loan size limits
set by the program, and either can't meet a 3% down payment requirement, have
poor credit, or both.
Most FHA borrowers make down payments of less than 3 percent. FHA allows you
to buy a home with 1% down. Private mortgage insurers require 5 percent down
on most loans, and only allow 3 percent down on special programs. FHA is also
liberal in allowing gifts to be used for paying settlement costs. (See Are
Seller Contributions Kosher?).
FHA borrowers also usually have weaker credit than private insurers accept.
FHA allows higher ratios of expense to income, is more tolerant of existing
debt, and will allow the income of co-borrowers who don't live in the house
to count fully in measuring income adequacy. It is also quite forgiving about
bad credit. For example, a borrower need be out of a Chapter 7 bankruptcy for
only 2 years, and out of a Chapter 13 bankruptcy for only 1 year.
But there is a third group of FHA borrowers that shouldn't exist. It is comprised
of borrowers like you who would meet the requirements of a conventional loan
but are steered to an FHA. They pay more for their loan than they should.
FHA loans are generally available in the market at about the same interest
rate and points as conventional loans with the same term. There may be a difference
in mortgage insurance premiums, however.
On an FHA 30-year fixed-rate mortgage (FRM), the mortgage insurance premium
is 1.5% of the loan amount paid up front plus .5% of the loan balance paid monthly.
The premium is the same regardless of the down payment.
On conventional loans, the insurance premium depends on the down payment. With
5% down, the premium on a 30-year FRM is about the same as on an FHA. With 10%
or more down, the premium on conventional loans is lower. Borrowers who can
put 10% down and have good credit will usually do better with a conventional
loan.
Recently, an additional option has opened for borrowers who are unable to make
a down payment but have strong credit. The interest rate is higher on these
zero-down-loans, but you don't have to pay for mortgage insurance.
I recently compared the best deal I could find on the internet on an FHA 30-year
FRM with the comparable zero-down loan offered on-line by Countrywide Funding,
one of the major lenders offering such programs. The FHA loan was at 8% and
zero points while Countrywide's loan was 8.375% and 1.25 points.
When you factor in the FHA mortgage insurance premium, the cost of the FHA
was higher. Assuming no other charges on either loan, the "all-in"
cost of the FHA over 30-years was 8.75% compared to 8.51% on the Countrywide
loan. Over 5 years, the difference is even greater, 9.07% compared to 8.69%.
Cash-poor borrowers with good credit should explore this new option.
Updated March 14, 2003
