Harney: Premium cut good news, but may not last

Say you want to buy a house and find one for $220,000, which is slightly below the median national price of existing homes at the end of last year. You’ve got a 720 FICO credit score and can make a 5 percent down payment, resulting in a loan amount of $209,000. Before the cut in FHA fees, at typical interest rates quoted earlier this month, you’d have paid $1,153 monthly (exclusive of property taxes and hazard insurance) for an FHA-insured mortgage. The same loan but with private mortgage insurance would have cost $2 more a month — $1,155. On monthly payments, your FHA loan and a conventional Fannie/Freddie alternative would have cost about the same.

After the premium reduction, however, the monthly cost for the FHA loan will be $45 cheaper than the competing conventional loan — a cost advantage of $540 the first year. For larger sized loans, the savings will be greater. No big deal? It depends: For new home buyers short of cash, any savings can be important. Plus at the application stage, the lower mortgage cost helps buyers’ debt-to income (DTI) ratio calculations — a crucial factor in loan approvals and rejections.

What about first-timers who can’t come up with any more than the absolute minimal down payment allowed on either FHA (3.5 percent) or Fannie/Freddie conventional mortgages (3 percent)? Here the cost differentials become significantly greater. Purchasing the same $220,000 house with a 720 FICO score and a 3.5 percent down payment FHA loan will cost you $129 less per month following the premium reduction compared with a 3 percent down conventional loan eligible for sale to Fannie Mae or Freddie Mac, according to an analysis prepared by Paul Skeens, president of Colonial Mortgage Group, a lender based in Waldorf, Md. The FHA payment comes to $1,088.45, the conventional loan payment to $1,217.45.

You might say, wow, it looks like for new low down payment buyers, FHA is always the way to go. But that’s not the case. Keep these pros and cons in mind when you comparison shop for a mortgage requiring minimal dollars down:

Both FHA and conventional loans require payment of mortgage insurance premiums. But FHA loans come with a glaring negative: Unlike private mortgage insurance, FHA premiums are non-cancellable for the life of the loan if you make less than a 10 percent down payment. With a conventional loan, you get to cancel your premium payments when you achieve a 20 percent equity stake in the house. That can occur when your principal payments reduce your debt to 80 percent of the original balance or an increase in the market value of your house grows your equity.

When your loan balance declines to 78 percent — your equity is 22 percent — your loan servicer is required by federal law to terminate premium payments.

On the plus side, FHA has far more generous and forgiving underwriting rules on credit, debt-to-income ratios and financial assistance from home sellers to help with buyers’ closing costs. It exists to serve working families and individuals who might otherwise find it difficult to get an affordable loan. If your FICO credit score is below 720 and you can cobble together a 3.5 percent down payment, FHA is usually the right choice.

The new, lower premiums merely underline that fact.

Kenneth R. Harney of the Washington Post Writers Group is a past member of the Federal Reserve Board’s Consumer Advisory Council and is currently on the board of directors of the National Association of Real Estate Editors. Reach him at KenHarney@earthlink.net.