FHA Loans Insured but Costly
By: Vanessa Rodriguez
August 13, 2010 (FreeRateUpdate.com) – The interest rates on FHA and conforming loans are very similar. Currently, a 30 year fixed conventional loan is 4.125 percent and an FHA loan is 4.0 percent. The Federal Housing Administration insures loans that conform to standards set by Fannie Mae and Freddie Mac. However, loans that conform to those standards are not necessarily FHA-insured. The FHA will insure loans based on the riskiness of the prospective borrower, such qualifications include low credit scores and low down payments. Despite their interest rate similarities, recent developments are such that an FHA loan is actually more expensive.
The key difference between conforming loans and FHA loans is the annual percentage rate. APR incorporates costs, such as the interest, mortgage insurance, and origination fees that are required for a loan, and expresses it as a percentage rate. A 30 year fixed FHA mortgage may have a 4.0 percent interest rate, but when the other costs are taken into accounts, its APR jumps to 5.178 percent. Consider its counterpart, the conforming mortgage loan, whose APR is only 4.323 percent for a 30 year fixed mortgage.
Origination fees for conforming loans and FHA loans are identical at 0.7 and 1 point. The major discrepancy is fueled by those extra costs inherent in an FHA loan. Three major changes occurred this year that contributed to higher expenses: reduced seller concessions, increased down payment requirements, and increased mortgage insurance premiums.
It is customary with an FHA loan for sellers to contribute funds toward the sale of the home, such as closing costs and inspections. In previous years seller concessions were 6 percent of the selling price. In February of this year, FHA reduced the allowable seller concessions to 3 percent. This translates into fewer incentives for buyers.
FHA is also tightening the reins on credit scores and increasing down payments. Borrowers with a score below 580 are required to have a down payment of at least 10 percent, instead of the customary 3.5 percent. FHA claims that borrowers with a high credit score are less likely to default on a mortgage loan.
As of April 2010, the upfront mortgage insurance premium for an FHA-insured loan increased from 1.75 percent of the total loan amount to 2.25 percent. This translates into a $500 increase for every $100,000 borrowed. However, this is just the beginning. David Stevens, the FHA Commissioner, announced that on September 7, FHA will drop the upfront mortgage insurance premium to 1 percent of the total loan amount, but nearly triple the annual mortgage premium from 0.55 percent to 1.50 percent. Stevens said that the premium would increase gradually, first to 0.85 percent then to 0.9 percent, etc. Although, this recent development will soften the upfront blow to borrowers, the mortgage would be more expensive over the life of the loan.
Reducing the number of mortgage defaults is one reason that the FHA is raising the bar. But, it is not the primary reason. Last year, an audit revealed that FHA attained capital reserves of 0.53 percent. Congress mandates that the Federal Housing Administration maintain 2 percent capital reserves. This poses a big risk for FHA as the number of 90-day delinquencies, bankruptcies, and foreclosures are expected to rise and unemployment nears double digits nationwide. If the capital reserves are not sufficient to cover mortgage defaults, then FHA may very well become bankrupt. According to Stevens, the new annual mortgage insurance premium alone is expected to increase reserves $3.6 billion annually.