NEW YORK (MainStreet) Shopping for a mortgage? Before going the ordinary route, take some time to consider an FHA loan, which comes with a benefit that can be especially appealing at a time of rising interest rates: assumability.
In other words, when it comes time to sell your home, a potential buyer may qualify to simply take over your mortgage at today's relatively low interest rate rather than resorting to a new loan, minimizing your buyer's monthly payment. That could be a strong selling point if, at that time, new mortgages charged more. Assumability could make it easier to find a buyer, and perhaps to get a higher sales price.
Unfortunately, FHA loans carry some heavy upfront costs, which need to be weighed against the uncertain value of the assumability feature. Assumability could be quite valuable if mortgage rates were much higher when you decided to sell your home but won't have any value if rates fall, stay the same or rise only a tad.
FHA stands for Federal Housing Administration, a federal agency that provides insurance so lenders will approve mortgages to applicants who probably could not qualify for conventional loans. FHA borrowers, for instance, may be permitted to make down payments as low as 3.5%, while most lenders require 10%, 15% or even 20% for conventional loans. And FHA loans can be issued to borrowers with less-than-enviable scores.
Just about anyone can apply for an FHA loan, including borrowers who could get conventional loans, so long as the mortgage is used for a primary residence.
To offset the risk that leniency involves, the FHA requires an hefty upfront insurance premium of 1.75% of the loan amount, then an annual insurance charge of 0.45% to 1.35% of the loan. That second charge lasts the life of the loan and would continue to be paid by anyone who assumes the mortgage.
Currently, FHA rates are slightly lower than those on conventional mortgages about 4.2% versus 4.6% for a 30-year fixed-rate loan.
So if you can't qualify for a conventional loan but can get an FHA loan, this is a no-brainer: Take the FHA deal and count the assumability feature as gravy. Keep in mind that, just as you must, your buyer must meet the qualification requirements to assume you can't just hand the loan off to anybody.
But what if you can get an ordinary loan? Would an FHA mortgage make sense just because of the assumability?
That's a tough call, as there are various uncertainties in the calculation. As mentioned, it assumes your FHA loan could be very attractive to your future buyer if mortgage rates are much higher at the time, but for you that marketing benefit is undercut by the additional mortgage insurance costs.
Another factor is how long you expect to have your FHA mortgage. If it's to be a short time, the big upfront premium is probably not worth paying. And if it were a very long time, the annual insurance cost adds up. With a conventional loan, you can eventually get free of any mortgage insurance obligation, and you might not even have one at all if you make a 20% down payment. With an FHA loan, this cost continues for the life of the loan.
Also, the longer you have your FHA loan, the smaller your loan balance will be when you are ready to sell the home. If your $200,000 loan had been whittled to $170,000 by years of payments, the loan assumption would provide your borrower with just $170,000. So if your home had grown in value, the borrower would have to come up with a lot of cash to make up the difference, or would have to take out a second loan at the higher rates prevailing at the time.
Another uncertainty is the health of the economy and housing market when you are ready to sell. In good times, there might be plenty of buyers, so you'd have paid the extra FHA insurance costs for nothing. In a poor economy, lots of buyers might be attracted to your FHA loan.
No doubt about it, this is a tricky calculation. To weigh your options, use the Mortgage Loan Calculator (of principal, interest, taxes and insurance), or this alternative. If mortgage rates soar to 7% or 8%, a buyer would be eager to assume your FHA loan charging only 4.1%. But whether rates will go that high, and when ... well, that's anyone's guess.
--Written by Jeff Brown for MainStreet