Thanks to shifts in the lending landscape, the dream of buying a home is becoming a reality for many Americans. The Federal Housing Administration (FHA) recently made a drastic 0.5-percent cut to mortgage insurance fees, making this 3.5-percent down payment loan option much more affordable for home buyers. And just before that, Fannie Mae and Freddie Mac rolled out loans that require down payments of just 3 percent.Given these new developments, how can you determine which low down payment loan is right for you? The first step is understanding the associated fees.
The fine print: FHA fees
The FHA doesn’t make loans, but rather insures loans that lenders make. They do this using a fund that’s maintained by borrower-paid mortgage insurance. You pay this mortgage insurance as an additional fee on top of your monthly mortgage payments.
The amount of the fee fluctuates because federal regulations require the FHA to have enough money in its insurance fund to cover loans that might not get paid back. As FHA loans grew in popularity after the 2008 financial crisis, more loans didn’t get paid back, leading to fund losses that forced the FHA to raise mortgage insurance fees five times: from .55 percent of a loan amount in 2010 to 1.35 percent in 2013.
Now, with the FHA’s fund deemed more stable as housing has recovered, the agency has cut the fee from 1.35 percent per year to .85 percent per year (paid monthly) for 30-year fixed loans up to $417,000 with as little as 3.5 percent down.
This is great news for home buyers, but it’s critical to note three other FHA budget considerations:
- You’ll also pay 1.75 percent of your loan amount up front in cash or by adding this extra fee to your loan amount.
- If you’re getting a 30-year fixed with 3.5 percent down, you’ll pay the .85-percent annual fee as long as you have your loan.
- The annual mortgage insurance isn’t tax deductible.
The Fannie and Freddie route
FHA isn’t the only low down payment option. Fannie and Freddie just announced a program requiring as little as 3 percent down.
These loans require non-FHA mortgage insurance — called private mortgage insurance (PMI). It costs about 1.05 percent per year (paid monthly) for 30-year fixed loans up to $417,000 with 3 percent down. There is no additional up-front fee, you can eliminate the mortgage insurance in as little as two years by paying your loan down to 78% percent of your home purchase price, and your mortgage insurance may be tax deductible.
Comparing low down payment loan options
Now that we’ve got a handle on the fee structures, let’s compare FHA vs. PMI loan options. We’ll use the example of a $300,000 single-family home purchase using a 30-year fixed loan and a 3.5-percent down payment. Remember, FHA allows 3.5 percent down and PMI allows 3 percent down, but we’ll do both loans at 3.5-percent down to compare monthly costs accurately.
|FHA Loan||PMI Loan|
|Loan Amount||$294,566 *||$289,500|
|Mortgage Insurance||$205 **||$253 ***|
|Total Monthly Cost Before Homeowner Tax Deductions||$1,928||$1,994|
|Total Monthly Cost After Tax Deductions||$1,580||$1,633|
* With 1.75% upfront FHA fee added ** At FHA’s new .85 percent rate *** At PMI rate of 1.05 percent for 3.5 percent down
Even after adding FHA’s 1.75-percent upfront fee to your loan amount, the FHA loan costs $66 less on a total monthly cost basis, and also costs less (by $53) after homeowner tax deductions. This is because the FHA’s mortgage insurance rate cut takes makes its fee lower than PMI fees for this 3.5-percent down payment.
However, if you were using a down payment of 5 percent, the PMI fee drops from 1.05 percent to .54 percent, and the PMI total monthly cost options become slightly lower. If you take this 5-percent down PMI route, ask your lender about “lender paid mortgage insurance” which builds mortgage insurance into your mortgage rate, thus making it a tax deductible fee and saving you approximately $100 more per month after your homeowner deductions.
Both FHA and PMI options are viable for home buyers with steady income but not a lot of savings. Your lender can work with you to find the most affordable option based on your credit score, reserves left over after your down payment, and your expected time in the home.