For young home buyers carrying a large burden of student debt or for people with lower incomes, an FHA loan provides a viable way to become homeowners. FHA loans have become very accessible to those with less than stellar credit or with little money for a down payment. As government-backed loans, FHA loans make home ownership possible with relaxed lending requirements and down payments as low as 3.5%. But there is a cost, and a conventional loan is sometimes a better option. So how much more will an FHA loan really cost vs. a conventional loan in Baltimore?
What Is an FHA Loan?
According to lending experts, an FHA loan is, basically, “a government-backed mortgage insured by the Federal Housing Administration, or FHA for short. Popular with first-time homebuyers, FHA home loans require lower minimum credit scores and down payments than many conventional loans. Although the government issues the loans, they are offered by FHA-approved mortgage lenders. . . . FHA’s flexible underwriting standards allow borrowers who may not have pristine credit or high incomes and cash savings the opportunity to become homeowners.”
Here are the salient features of FHA loans:
- Backed by the U.S. Federal Housing Administration (FHA)
- Requires a down payment as low as 3.5%
- Requires a credit score of only 580
- No minimum income required
- Can be for 15 or 30 years
- The borrower must carry mortgage insurance
And that mortgage insurance is the catch – the thing that can make an FHA loan cost more than a conventional loan in Baltimore.
FHA Mortgage Insurance
Mortgage insurance, which the borrower pays for, is typically required for all mortgage loans when the borrower pays less than 20% down. Its purpose is to protect the lender in case the borrower defaults. Mortgage insurance is required for all FHA loans, and the money goes into a fund as protection against default, which can frequently happen owing to the more relaxed lending standards. There is an upfront fee to be paid at closing (or rolled into the loan) and then a monthly fee to cover the yearly premium.
The upfront mortgage insurance premium is 1.75% (for 3.5% down) of the loan amount but can be rolled into the loan. The annual premium can range from 0.45% to 1.05%, depending on whether the loan term is 15 or 30 years and the borrower’s credit, of the loan amount and initial loan-to-value ratio. And this mortgage insurance can add up to a significant amount of money over the life of the loan.
One influential financial adviser comments: “FHA loans allow you to get a mortgage and buy a home sooner, but they come at a cost. If you can qualify for a conventional mortgage instead, you may save thousands over the life of the loan.”
How Much More an FHA Loan Will Cost in Baltimore
The upshot, then, is that the advantages of an FHA loan come at a pretty hefty cost (mostly in the form of mortgage insurance), and a conventional loan may cost much less over the long haul. Let’s take a look.
If, for example, your FHA loan amount is $200,000, the 1.35% upfront mortgage insurance premium will be $2,600. This cost will, however, be rolled into the loan amount, and you will pay it off monthly over the loan term. The percentage for the annual premium will vary based on your credit score. But assuming 0.85%, you will pay $1,700 annually (around $142 each month) for this yearly mortgage insurance premium. Multiply that by 30 years, and that’s big chunk of money. In addition, this private mortgage insurance cannot be canceled for FHA loans, as it can be for conventional loans when the loan is paid down to 78% of the original purchase price.
Further, the 2013 changes have made FHA loans even less attractive. If you pay at least 10% down the mortgage insurance premium still lasts 11 years, and if you pay 3.5%% it will last for the term of the loan. And if you want to get rid of it, you will have to refinance.
This may not be a big deal for a relatively inexpensive starter home in areas where housing costs are reasonable. But in areas where housing is sky high, this private mortgage insurance can run into many thousands of dollars. Here’s an eye-opening example from the financial experts . . .
“Fora two bedroom condo costing $430,000, a 3.5 percent down payment would be $15,050, leaving $414,950 to be financed. The upfront MIP of 1.75 percent would tack on an additional $7,261 to your closing costs, bringing the upfront costs to $22,311. The annual payments (at .85 percent of the loan amount) would add another $3,500 to your yearly costs, or just under $300 a month. That’s a lot of money to set your lender’s mind at ease.”
Your Local Agent Can Help
So now you have a general idea of how much more an FHA loan will really cost vs. a conventional loan in Baltimore. But that’s not to say an FHA loan is always a bad idea. For some people, it’s the only option for owning a home. But which route is best for you? Your local real estate agent can provide some invaluable guidance here.