I often hear agents and buyers express shock and dismay when the real numbers that make up mortgage insurance for an FHA loan are finally on the table, down and dirty for everyone to see.
What they should be doing is thanking their lucky stars there is still an FHA loan around to loan money at rates that are WAY TOO LOW for the RISK the loan carries.
In a market like ours (the San Francisco Bay Area) it is common for FHA buyers to buy $500,000 + houses with the standard 3.5% down.
The good news? 3.5% down on a $500,000 house is $17,500.
The bad news?
- $8443.75 in up front mortgage insurance added to the loan.
- $502.60 added to each payment as monthly mortgage insurance.
Okay, do you say "OUCH"? Or do you say "YEAH, BABY, send me those disclosures. I'm buyin' a house!"
Going to stop right here and honestly admit that "OUCH" coupled with a look of pure disbelief is the norm. But there is a better way to think about paying mortgage insurance and that is to think about the ALTERNATIVES and the REASON for the insurance in the first place.
In lending, the riskier the loan, the higher the rate of interest a borrower must pay. We already KNOW that loans with only 3.5% down are as risky as heck.
Remember this formula: the lower the equity in the house, the greater the RISK the borrower will walk away (read strategic foreclosure waiting to happen).
Gosh, you think a few lenders have suffered defaults as a result of those 100% loans we used to do? Do you think the lender is also just a little bit nervous that if the house slips in value just the tinest bit the borrower would then be underwater? (security for the loan just vanished into thin air).
I will speculate that if there was no FHA, buyers without the full 20% downpayment would have these choices:
- Save up the 20% down. That would be $100,000 instead of the $17,500). Okay, that is an OUCH.
- Pay a MUCH higher interest rate. The rate for a loan with only 3.5% down would be astronomical to cover the RISK associated with it. You don't even want to THINK about that rate. Trust me.
Instead, the borrower pays mortgage insurance and gets a LOW LOW rate. He also gets many liberal underwriting "breaks" that non-FHA loans do not enjoy.
Finally, the FHA buyer does not need to wait until he can accumulate $100,000 to buy a home (when rates could be far higher and houses much more expensive). He can buy right now at this intersection of low prices and low rates.
Remember that mortgage insurance is just like any other kind of insurance. Everyone must pay into a pool to spread and cover the risk. Those with the MOST RISK must pay the MOST INSURANCE. If there is NO INSURANCE then there will be no one willing to absorb the risk and the product simply disappears.
Witten by Janet Guilbault, Mortgage Banker and FHA Loan Specialist in the San Francisco Bay Area
NMLS # 238304