Comparing FHA and Conventional Mortgages with Less than 20% Downpayment

Private Mortgage Insurance is an insurance policy that is paid by homeowners for the benefit of lenders. It's required for all conventional-mortgage homeowners whose loans exceed 80% loan-to-value.

Similar to homeowners insurance, private mortgage insurance gets "cashed in" when a loss occurs. In the case of the former, the loss may be storm damage; the latter, mortgage default. With foreclosures proliferating, PMI defaults are up 26 percent over last year and double the levels from 2007. Private mortgage insurers are paying out on many more claims than was expected and, as a result, are booking huge losses.

Homeowners are about to pay the price. To shore up balance sheets and protect against future losses, mortgage insurers have raised insurance rates and toughened underwriting guidelines.

Some of the changes we're seeing include:

Minimum FICO requirements of 720 based on loan-to-value
Maximum debt-to-income ratios of 41%, regardless of Fannie Mae approval
Loan size limitations, based on the health of the local real estate market
And, of course, insurance premiums are increasing for everyone.

It's a 2-pronged attack that will make a less-than-20%-downpayment more costly for Fannie Mae- and Freddie Mac-backed mortgage.

The alternative is to look to the FHA for a mortgage. There's 3 advantages here.

First, as compared to PMI rates, FHA mortgage insurance looks cheap. A $200,000 FHA home loan with 10% down can save as much as $400 in insurance costs. With 5% down, that number grows to $1,040 per year.

Second, FHA mortgage insurance has a finite lifespan.

After 5 years -- no matter what your home is worth -- FHA mortgage insurance is no longer required. Compare this to homeowners with conventional PMI who are required to make payments until their home's loan-to-value drops to 80%.

And, lastly, with FHA mortgage rates running neck-and-neck with conventional ones, there's a lot of days when 30-year fixed mortgage rates are cheaper in the FHA market versus the conventional one.

The downside of FHA is that the government adds up to 1.750% insurance fee at the time of closing that's added to your loan size. It's a cost that doesn't exist in the conventional world and, for some people, the fee makes FHA an imperfect fit.

The key is to talk with your loan officer about Conventional and FHA mortgages to make sure you're making the right choice.

For help with your FHA vs Conventional decision, send me an email anytime with the details of your situation. I answer all of my own emails and am happy to help you with what I know.