Ask Our Broker With Peter G. Miller
By Peter G. Miller
Question: Our lender says we should avoid FHA financing and instead go with a conventional loan and private mortgage insurance. The two advantages are a smaller down payment requirement and the ability to cancel mortgage insurance. Is she right?
Answer: Ask a loan officer to create table with three 30-year mortgage options â€“ FHA, conventional with mortgage insurance and conventional without mortgage insurance. For each option look at the minimum required credit score, maximum debt-to-income ratio (DTI), required down payment, interest rate, annual percentage rate (APR), monthly payment and total cash required at closing.
What you likely will see is the conventional loan without mortgage insurance has the highest rate â€“ but the lowest monthly payment. Why? The rate is higher because the lender is self-insuring the loan, so there is no separate cost for mortgage insurance. The result is often cheaper than financing with a separate monthly insurance expense.
Second, the right to cancel mortgage insurance is simply irrelevant for most borrowers. Mortgage insurance is a cost, so naturally borrowers want to end it as quickly as possible. Under the Homeowners Protection Act, lenders must cancel mortgage insurance in most cases when the loan balance falls to 78 percent of the original debt. Also, you can ask lenders to cancel once the balance falls to 80 percent of the original balance.
With the FHA, the situation is different. It used to allow borrowers to cancel the annual mortgage insurance premium (annual MIP) in as little as five years if the loan balance had been reduced to 78 percent of the original debt. However, in 2013 it changed the rules to say that the MIP would remain in place for the life of the loan for borrowers who financed with less than 10 percent down â€“ meaning virtually all FHA borrowers.
As a borrower you likely donâ€™t care when mortgage insurance can be canceled. The reason is that most loans never reach a point where they are sufficiently reduced to qualify for cancellation. For example, according to Freddie Mac, the typical mortgage was refinanced after 7.6 years in the first quarter of 2017, however, in previous quarters loans have been refinanced on average after four and five years. The National Association of Realtors says homes are usually sold within 10 years.
The bottom line: Have lenders prepare a comparison chart so you can see the result of various FHA and conventional choices. And if someone mentions canceling mortgage insurance, understand that you will most likely refinance or sell the property long before cancellation becomes a real option.
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Peter G. Miller is author of â€œThe Common-Sense Mortgage,â€� (Kindle 2016). Have a question? Please write to email@example.com.
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