Buyers who can't afford to put 20 percent down on their home purchase will probably have to consider an FHA loan vs PMI. Should they choose a conventional (non-government) mortgage and pay private mortgage insurance (PMI) premiums, or should they opt for FHA financing and buy its mortgage insurance (MIP)? FHA used to be the obvious go-to for borrowers with small down payments, but that is changing. The growing cost of Federal Housing Administration (FHA) mortgage insurance is causing more home buyers and homeowners to consider conventional loans and PMI as an alternative to the increasing cost of FHA loans.
FHA MIP Rates
FHA mortgage insurance has two components: a 1.75 percent upfront mortgage insurance premium, which can be paid at closing or rolled into the mortgage amount at closing, and an annual MIP that's divided by 12 and added to the monthly mortgage payment. The 2014 table below shows annual MIP charges for different FHA loans.
If the down payment on the same mortgage is less than five percent, MIP is 1.35 percent of the loan value. That's like adding 1.35 percent to the mortgage rate! And unlike private mortgage insurance, FHA insurance is forever -- it's required for the life of the loan.
PMI and Conventional Mortgages
Conventional (non-government) loans also require mortgage insurance. The lender either self-insures by charging a higher interest rate, or requires the borrower to purchase mortgage insurance from a private insurer. The cost of PMI is based on a host of factors, including the loan amount, credit score and down payment, says Stephanie Noryko, broker and owner of Granite Financial Real Estate Loans in Cupertino, CA. "It's case-by-case. You have to be open to both [FHA and conventional loans] and you need a professional to sort through it."
Here's what lending pros see -- a rate card from a large private mortgage insurer.
FHA Loan vs PMI: Comparisons Have Gotten Easier
The difficulty in comparing an FHA loan vs PMI coverage is that conventional mortgage lenders work with different PMI companies, and they set their own rates. However, it's gotten much easier to make this comparison with LendingTree's LoanExplorer tool. Users just put in their parameters -- their credit rating, property location, its sale price and their down payment. They can view offers (there are all kinds of handy filters and sorting options) and get the details of each offer -- making it easy to compare FHA and conventional options side-by-side.
For example, a buyer with five percent down, a 680 FICO score and a $200,000 FHA mortgage would pay a 1.75 percent upfront charge of $3,482 and $218 per month for mortgage insurance. That goes down over time as the loan balance drops, but coverage is required for the life of the loan. That same buyer with a conventional loan would probably pay .89 percent for PMI, providing the lender with 30 percent coverage. There's no upfront mortgage insurance premium and the monthly premium (starting at $148 and dropping as the loan balance does) goes away when the loan has been paid down to 78 percent of the original purchase price -- in this case, $163,800.
When comparing conventional loans with PMI against FHA loans and MIP, home buyers need to look at a couple of other things. Conventional lenders that sell their loans to Fannie Mae or Freddie Mac (most lenders) are required to collect extra fees from borrowers with riskier profiles. For example, a buyer with five percent down, a 620 FICO, purchasing a condominium unit faces additional fees totaling four percent of their loan amount. For a $200,000 loan, that's an extra $8,000! The fees can be paid in cash, or the mortgage rate can be increased to cover the cost -- four points adds .5-.75 percent to the mortgage rate. That person will also pay more for private mortgage insurance -- 1.15 percent, or $192 a month to start. For this person, the FHA loan might be a better deal.
Finally, buyers may not have a choice in their financing. Not every condominium project, for example, is approved for both FHA and conventional financing. And applicants with riskier profiles may find that FHA is the only game in town.