How to Avoid a Higher-Priced Mortgage Loan

Mortgage closing costs can add up at the closing table and over the life of a home loan. One way to avoid a higher-priced mortgage loan may be to stay away from government-backed loans insured by the Federal Housing Administration (FHA). Borrowers often choose FHA loans for their flexible underwriting guidelines, but the short- and long-term costs may outweigh the benefits.

What is a higher-priced mortgage loan?

A higher-priced mortgage loan (HPML) is a mortgage with an annual percentage rate (APR) that’s higher than the average prime offer rate (APOR) offered to well-qualified borrowers.

The APOR is set by the Federal Financial Institutions Examination Council (FFIEC) and is based on a weekly survey of average interest rates and terms offered to highly qualified borrowers.

Because HPML loans typically come with higher interest rates, monthly payments and closing costs, lenders are required to take extra precautions to make sure you can repay your loan (more on this below).

Your APR is not the same as your interest rate; rather, it’s a measure of the cost to borrow your mortgage and includes origination fees, discount points, mortgage insurance and other costs.

HPML rules only apply to first mortgages, second mortgages and jumbo loans on homes used as your primary residence.

Your mortgage may be considered a higher-priced mortgage loan if:

• You have a first mortgage with an APR that is at least 1.5 percentage points higher than the APOR
• You have a second mortgage with an APR that is at least 3.5 percentage points higher than the APOR
• You have a jumbo loan with an APR that is at least 2.5 percentage points higher than the APOR

What are HPML requirements?

If your mortgage is considered an HPML loan, lenders must take extra steps to prove you can repay it. These include:

• Obtaining a home appraisal. HPML loans may trigger a home appraisal requirement for loan programs that don’t typically require one, such as an FHA streamline refinance.
• Obtaining a second appraisal. If you’re buying a home that was recently “flipped” (purchased, fixed up and re-listed for sale within a short time period) the lender might order a second appraisal.
• Maintaining an escrow account for at least five years. Lenders may require you to establish an escrow account, regardless of your down payment amount, to ensure your property tax bills and homeowners insurance premiums are paid on time.
• Confirmation you are borrowing at least $28,500. HPML rules apply to loan amounts of $28,500 or higher. If you’re borrowing less than that, you’ll be exempt from the extra HPML requirements.

Where you live influences how your lender handles an HPML loan, but your loan officer should be familiar with the guidelines that apply to your situation.

How to avoid HPML loans

The Consumer Financial Protection Bureau’s 2019 Mortgage Market Activity and Trends report found that just over 1 in 10 of all home loans used to buy one- to four-unit, owner-occupied site-built homes in 2018 to 2019 crossed the HPML threshold. However, government-backed loans, manufactured homes and purchase loans were more likely to be higher-priced.

Here are five key ways to avoid an HPML loan:

1. Don’t take out an FHA loan

First-time homebuyers often opt for FHA mortgages because they allow for lower credit scores and higher debt-to-income (DTI) ratios (to note, DTI ratios measure your total monthly debt compared to your gross monthly income). However, in 2019, 36.5% of FHA loans were higher-priced, according to the aforementioned CFPB report.

Three features of FHA loans often lead them to cross the HPML threshold:

1. Two types of mortgage insurance are required. FHA borrowers pay a lump-sum upfront mortgage insurance premium (UFMIP) of 1.75% of their loan amount, plus an ongoing annual mortgage insurance premium (MIP), which ranges from 0.15% to 0.75% and paid as part of the monthly mortgage payment. FHA mortgage insurance premiums are factored into the APR calculation.

Some good news about FHA annual MIP in 2023:

The FHA recently reduced FHA MIP by 30 basis points, which may reduce the chances that you’ll end up with a higher-priced FHA loan – and save the average homebuyer $800 annually..

2. Mortgage insurance is paid for life with a minimum down payment. A 3.5% down payment comes with lifetime mortgage insurance premiums. A down payment of at least 10% may allow you to stop paying MIP after 11 years — otherwise, MIP can’t be removed even if your home’s value rises.

3. Credit score minimums may lead to higher interest rates. FHA-approved lenders offset the risk of allowing lower credit scores by charging higher interest rates. This means you might pay more for your FHA loan over the long term compared to other mortgage types.

2. Boost your credit scores so you qualify for a conventional loan

Conventional mortgages require private mortgage insurance (PMI) when you put down less than 20% —though PMI can be removed after you’ve reached 20% equity.

Save money on mortgage insurance costs — and avoid the additional HPML restrictions — by taking some extra steps to boost your credit scores above 620:

1. Pay your credit card balances down. Keeping your credit account balances below 30% of your total available credit will go a long way to increasing your scores — plus, it’ll also lower your DTI ratio.

2. Pay everything on time. A recent late payment will damage your credit score, so put your payments on autopay to avoid missing a payment. If you do pay late, wait three to six months to give your scores time to recover before applying for a home loan.

3.   Shoot for a credit score above 780 to get the best conventional rate. Fannie Mae and Freddie Mac, the government agencies that set rules for conventional loans, changed the credit score standard to 780 to avoid charges that affect your interest rate; this is 40 points higher than the previous threshold of 740. The changes will be effective after May 1, 2023.

4.   Consider paying off debt to reduce your DTI ratio for conventional loans. Conventional lenders will be required to assess a fee equal to 0.25% to 0.375% of your loan amount for borrowers with a DTI ratio above 40% after Aug. 1, 2023. The fee may be added to your closing costs, charged to you as a higher interest rate or a combination of both.

3. Make a bigger down payment

The bigger your down payment, the lower your conventional PMI premiums will be. Lower monthly mortgage insurance costs lead to a lower APR, which may help you dodge the HPML threshold. In addition, making a 20% down payment means you’ll avoid mortgage insurance altogether.

4. Ask the seller to pay closing costs

Lenders calculate your APR based on the amount of costs you’ll actually have to pay. FHA loans allow a seller to pay up to 6% of the purchase price toward your closing costs. This could help push your APR below the HPML limits, so you won’t have to deal with HPML requirements.

5. Buy a site-built home

Although manufactured home loans account for a small percentage of originations each year, in 2019, they exceeded the HPML limits about 70% of the time for both conventional and FHA purchase loans.

Which loans are exempt from HPML requirements?

• Construction loans. HPML rules don’t extend to construction loans to finance a newly built home. However, the rules do come into play with any permanent mortgage used to replace the construction loan after the home is completed.
• Rural and underserved areas. If you’re buying in a rural area and taking out a mortgage at a smaller bank, you might not need an escrow account.
• Planned unit development or condo association insurance. Buyers may not have to add the cost of homeowners insurance to an escrow account if their monthly homeowners or condominium association has a master insurance policy that protects all of the units in the development. These types of policies may not cover losses like burglaries or fires inside your home, however — so make sure you buy a separate homeowners insurance policy to protect everything within the walls of your home.