Money matters when deciding between a U.S. Federal Housing Administration (FHA) mortgage loan and a conventional loan with private mortgage insurance.
Job one for mortgage buyers is to understand the differences between the two options. Here's how one industry expert breaks it down.
"FHA requires upfront mortgage insurance and monthly mortgage insurance for the life of the loan," explained Mark Ferguson, a realtor, real estate investor, author and the creator of Investfourmore.com. "That means you will have to pay the insurance when you buy the home -- it can be financed into the loan -- and every month as long as you have that mortgage."
Yet conventional loans with less than 20% down require private mortgage insurance (PMI), Ferguson added. "Different loans have different programs, but usually the cost is from 0.5% to 1% of the loan amount per year With some conventional loans the PMI can be removed after two or three years," he said. "For that to happen, the home's value must have increased or the loan paid off enough, for the loan to value ration to be 80% or lower. That means the loan amount needs to be 80% of the value of the home."
According to WalletHub in its 2016 Mortgage Insurance Report, consumers can save thousands on their decision between an FHA loan and a conventional loan with private mortgage insurance.
WalletHub provides some thumbnail sketches of the criteria involved in choosing between an FHA and a loan that carries private mortgage insurance:
- PMI vs. FHA: FHA loans should only be considered by buyers with low down payments and below-average credit scores (savings up to $11K). Everyone else should opt for PMI (savings up to $8K).
- FHA Popularity: FHA loans are roughly 51% more popular than conventional loans with private insurance policies.
- 2014 vs. 2016: FHA insurance costs have fallen by 29%, while PMI costs have declined by 47% for people with credit scores of 760+ and increased by 28% for people with fair credit (i.e., a score of 660 or below).
As FHA loans become more expensive as the U.S. housing market has improved in recent years, private mortgage insurance is experiencing a rebound, WalletHub reports. (FHA-loan originations have fallen by 39% from 2009 to 2015.) So which loan should a homeowner aim at - an FHA loan or a PMI-linked loan? WalletHub has a few ideas on that front, as well, using credit scores as a centerpiece.
"Consumers should assess their financial profile, down payment amount and credit score," advised Jill Gonzales, analyst with the company. "If your down payment is low and your credit score is below average -- 660 or lower-- you should aim for an FHA loan, which can save you up to $11,000 during the first five years. If you have an above average credit score and have managed to save a little more, you should opt for PMI, which will save you up to $8,000 in five years."
Consequently, it's imperative mortgage shoppers do all they can to beef up their credit scores before shopping for a mortgage. "Credit scores are of the utmost importance when it comes to mortgage insurance," Gonzales said. "Building up your credit score above 680 before buying a house will significantly reduce your insurance costs."
For borrowers with low credit scores, an FHA loan might be the only homeownership option, regardless of mortgage insurance, says Chris Ling, mortgage expert at NerdWallet. However, there are some downsides to FHA mortgage insurance, he says.
First, there is an additional upfront premium, which will be added to your loan balance, Ling noted. "The monthly premiums last for the life of the entire loan unless you got your FHA loan before June, 2013," Ling said. "Consequently, you have to refinance to a non-FHA loan to get rid of it, but you typically can't refinance the mortgage insurance until you have at least 20% equity in your home."
How and when you pay your premiums factors into the equation, as well.
"Unlike the FHA, a private mortgage insurance (PMI) can be either a monthly or single premium," says Ling. "Also, PMI can be cheaper, but you have to consider the fact that FHA loans often have lower interest rates."
It's important for consumers to shop around and ask their mortgage lenders about both FHA and PMI options to find out which fits their needs best, says Gonzales. "They should also ask about hidden costs, like the FHA's up-front mortgage insurance cost that is typically financed into the loan amount," she advises.
Know, too, that mortgage insurance is not protecting the homeowner. "It's really protecting the lender in the event of you stop making payments, so it makes logical sense to assume that the mortgage insurer will analyze your credit scores to determine what kind of risk you are and how much you have to pay to insure your loan," explains Joshua Heckathorn, president of CreditNet.com.
There's a great deal of ground to cover when deciding between an FHA mortgage loan, and one that requires PMI coverage. To choose wisely, know your credit score, and make sure to work with a trusted mortgage professional.