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How to Avoid a Higher-Priced Mortgage Loan
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Getting a mortgage can add up at the closing table and with ongoing costs. One way to avoid a higher-priced mortgage loan may be to look beyond government-backed loans insured by the Federal Housing Administration (FHA). Although many borrowers choose FHA loans for their flexible underwriting guidelines, the short- and long-term costs may outweigh the benefits.
What is a higher-priced mortgage loan?
A higher-priced mortgage loan, or HPML, is a mortgage with an annual percentage rate (APR) that’s higher than the average prime offer rate (APOR) provided to well-qualified borrowers. HPML loans typically come with higher interest rates, closing costs and monthly payments.
Your APR is not the same as your interest rate; it’s a measure of the cost to borrow your mortgage and includes origination fees, discount points, mortgage insurance and other costs. The APOR is based on a survey of average interest rates and terms offered to highly qualified borrowers.
What are the HPML requirements?
If you aren’t able to avoid an HPML loan, lenders will need to take extra steps to ensure 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 purchased and listed for sale, more commonly known as a “flip,” 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.
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. Higher-priced mortgage loan guidelines apply only to a primary residence; the rules are different for second homes and investment properties.
How to avoid HPML loans
A recent LendingTree study analyzing high-cost loans found that Black borrowers are more likely to receive these loans than other borrowers in many of the country’s largest metros. That may be due, in part, to the fact that Black homebuyers chose non-conventional loans, such as FHA mortgages, nearly twice as often as non-Hispanic white buyers.
Here are four key ways to avoid an HPML loan:
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, a measurement of your total monthly debt compared to your gross monthly income. However, in 2019, 36.5% of FHA loans were higher-priced, according to the Consumer Financial Protection Bureau’s 2019 Mortgage Market Activity and Trends report.
Three features of FHA loans often lead them to cross the HPML threshold:
- Two types of mortgage insurance are required. FHA borrowers pay a lump-sum upfront mortgage insurance premium (UFMIP) of 1.75%, plus an ongoing annual mortgage insurance premium (MIP) ranging from .45% to 1.05% paid monthly in your mortgage payment. FHA mortgage insurance premiums are factored into the APR calculation.
- 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, but MIP can’t be removed even if your home’s value rises.
- Credit score minimums may lead to higher interest rates. FHA-approved lenders offset the risk of allowing low credit scores by charging higher interest rates. That means you might pay more over the long term for your FHA loan compared with other types of mortgages.
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%. PMI can be removed after you’ve reached 20% equity.
To save money on mortgage insurance costs and avoid the additional HPML restrictions by taking some extra steps to boost your credit scores to 620 or higher:
- 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. This will also lower your DTI ratio.
- 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.
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. And making a 20% down payment means you’ll avoid mortgage insurance altogether.
Ask the seller to pay closing costs
Lenders calculate APR based on how much costs you actually have to pay. FHA loans allow a seller to pay up to 6% of the purchase price toward your closing costs. That could help push your APR below the HPML limits so you don’t have to deal with HPML requirements.
What types of loans are exempt from the HPML requirements?
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. However, these types of policies may not cover losses such as a burglary or fire inside your home, so make sure you buy a separate homeowners insurance policy to protect your home.