New FHA rules lower up-front costs of homebuying

FHA loans have become more popular than ever in recent years as purchasers have struggled to come up with the necessary 20 percent down payment required for a conventional loan.

Previously, a common solution to the 20 percent problem was to obtain an 80 percent first mortgage and a 10, 15 or 20 percent second. However, with decreasing home values, lenders have significantly tightened the ability of purchasers to obtain second loans.

Since an FHA loan allows a purchaser to borrow up to 96.5 percent of the home value, quite often it is the only solution for a purchaser without a 20 percent down payment. New FHA rules went into effect on October 4, 2010, which will now reduce the loan amount at the closing, but increase the cost monthly.

For FHA loans, the upfront Mortgage Insurance Premium has been reduced to 1 percent. This is the second recent change, since the premium was increased in April, 2010 to 2.25 percent.

Because the upfront Mortgage Insurance Premium is rolled back into the loan, purchasers will not need to borrow as much at closing.

While this sounds great, it is the second component to the new rule which has altered the landscape significantly. The monthly mortgage insurance amount was increased from 0.55 percent to 0.85 percent on loans with more than 5 percent down and from 0.55 percent to 0.90 percent on loans with less than 5 percent down.

Since the minimum down payment on an FHA loan is only 3.5 percent, most FHA purchasers will fall into the latter category. This means that the monthly payment will increase since the monthly premium has increased.

So, to summarize, for homeowners using an FHA insured mortgage, the upfront cost of the loan will drop by a lot, but the long-term costs of the loan will grow.

This makes it more difficult for a low income buyer to qualify for a loan, since the purchasers’ debt-to-income ratios will be higher with the higher monthly payment.