FHA may no longer be the best source of a mortgage with a low down payment

July 12, 2013

It’s a crucial question for many first-time and moderate-income buyers in rebounding markets across the country: Where do we find the lowest-down-payment, lowest-monthly-cost loans? The answers are changing.

True zero-down alternatives are rare and tend to be tightly restricted. If you’re a veteran or active military, a VA-guaranteed home loan might be ideal since it requires no down payment. The same is true for certain rural housing loans administered by the Department of Agriculture, but purchases must be in designated areas outside large population centers. Members of the Navy Federal and NASA federal credit unions can qualify for zero down financing, but those programs are closed to everybody else. Some state housing programs may also be helpful, but they often come with income limits and other requirements.

For most shoppers looking for mini down payments, there are much larger, less restrictive sources. The Federal Housing Administration is probably the traditional favorite, since it requires just 3.5 percent down. But beware: In the wake of a series of insurance premium increases and a highly controversial move to make premiums non-cancellable for the life of the loan for most new borrowers, FHA no longer rules the low-cost roost.

Fannie Mae, the giant federal mortgage investor, may now do better. And for some applicants, so might Freddie Mac, Fannie’s smaller competitor.

Consider this scenario prepared by George Souto, a loan officer with McCue Mortgage in New Britain, Conn. He has long specialized in putting first-time buyers into houses using FHA loans, but lately, he says, “the numbers just don’t work as well.” He’s directing clients instead into Fannie Mae’s “My Community Mortgage” program, which has a 3 percent minimum down payment.

Here’s the head-to-head: Say you want to buy a $180,000 house and you don’t have much cash for a down payment. If you go with a 3.5 percent FHA loan, you would need to come up with $6,300. If you select Fannie’s 3 percent loan, it’s just $5,400.

In Souto’s hypothetical, the rate on the FHA loan with zero points will be lower — 4.25 percent — than the 4.625 percent for Fannie. (A point is 1 percent of the loan amount.) But FHA’s new mortgage insurance premium charges spoil the rate advantage: $195.41 monthly for FHA vs. $123.68 for Fannie’s plan using private mortgage insurance. On a monthly basis, FHA costs $43.30 more — $1,064.67 compared with $1,021.37 — for principal, interest and insurance.

More important for buyers who plan to hold on to their low mortgage interest rates for years, Fannie’s insurance charges disappear when the principal balance on the loan reaches 78 percent of the purchase price of the home; that knocks $123.68 off the monthly mortgage bill. FHA’s insurance fees of $195.41 a month, by contrast, are a drag until you pay off the loan. FHA previously allowed cancellation, but that changed June 3, when the agency revoked the privilege for most new borrowers.

Restrictions to the Fannie program might block certain buyers, however. There are income limits pegged to median incomes in the metropolitan area where the house is located, although applicants in higher-cost markets including the Washington area can qualify with incomes well above the median. Check with your loan officer about which ceiling may apply to you.

Fannie requires better credit numbers — generally, FICO scores of 680 and up — whereas FHA is more generous, allowing 580 FICOs. But as a practical matter, many mortgage lenders won’t do FHA loans for borrowers with FICO scores below 640. Fannie also insists that for first-time purchasers, at least one borrower must complete a financial education or counseling course. FHA has no such requirement.

FHA allows borrowers to use gift funds as part of their down payments, but the Fannie program requires that the full down payment come from the borrowers’ own resources such as savings accounts.

“Home Possible,” Freddie Mac’s low-down-payment competitor to both Fannie and FHA, may also be an attractive option for buyers who don’t want to keep paying expensive FHA insurance premiums for long periods. It requires a 5 percent minimum down payment but allows all of it to come from gifts provided by family, friends, employers or other sources. There is no minimum cash contribution directly from the borrower — which may resemble zero down but really isn’t.

Ken Harney’s e-mail address is kenharney@earthlink.net.

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