It’s no great revelation that accumulating a 20% cash down payment is a major barrier to home ownership. Even with the East Bay’s high median income (over $70,000 per household in Alameda County, nearly $80,000 for Contra Costa), saving up $60,000 to buy a $300,000 starter home is quite daunting.
That’s why low down payment programs like FHA (3.5% down) and conventional programs with Private Mortgage Insurance (3% down) have been so popular. FHA has been the clear favorite for several years, partly because of its lower rates, partly because of its more lenient underwriting standards. A buyer could have only so-so credit and buy that $300,000 home with a down payment of just $10,500. Mortgage insurance would be added to the payment, but the low monthly premium made the cost very appealing. A home buyer who had put $10,500 down on that $300,000 home would have a mortgage payment of just over $1,435 including MI.
Then FHA raised the cost of its MI—all the way to 1.35% from the previous .55%. That meant a payment of $1,633 for a new $300,000 purchase.
Meanwhile, private mortgage insurers have been getting a little bolder. Today, a buyer can make a 3% down payment and get a 97% conventional loan with MI. How much will the payment be? That’s a slightly more complicated question.
With a FICO score of 740 or higher, a buyer will get a no-points rate of 3.875% and a payment of $1,647 per month including mortgage insurance. The same buyer using an FHA loan will have a lower rate—3.375%—but a higher mortgage insurance premium. The mortgage payment with MI would be $1,633. Let’s call that a “push,” as my card playing friends like to say. With a lower FICO score—let’s say 680—the rate and payment are higher; a conventional loan would now have a rate of 4.25%, giving a mortgage payment of $1,710 including MI.
But what if the buyer wants a condo? For conventional loans, there is an additional adjustment, which will raise the rate to 4.125% for a well qualified borrower. The mortgage payment (with MI) will now be $1,689.
Here’s where it gets interesting: while FHA looks like the clear winner in both cases, not all condo developments are approved for FHA financing. In Dublin, CA, for example, there are only 25 condo developments approved for FHA financing in our community of 47,000 folks. In those cases, a conventional loan is the only choice for low down payment financing.
But there is another difference between the two: under FHA’s current guidelines, mortgage insurance must remain in place for the life of the loan. The only way to get rid of it is to refinance into a conventional loan once there is enough equity in the property to do so. This is not the case with private mortgage insurance. Under the Homeowner’s Protection Act of 1999, the lender must cancel the MI once the loan balance has been paid down to 78% of the original value of the home—or if the homeowner shows that the balance is 80% of the current value, as shown by an appraisal. Even though the initial payment is be a bit higher for a conventional loan, you may be able to lower it in just a couple of years by eliminating the MI by showing there is enough equity to protect the lender’s security interest.
Before you make an offer on that dream home or condo, you should make sure you are considering all the financing possibilities available to you.