Pay For it Now or Later
Many first time buyers believe that FHA financing is the only option for getting into a Aliso Viejo Real Estate home with a low down payment, that’s simply not true.
Conventional mortgage options using Private Mortgage Insurance are available with as little as a 5% down payment, or 5% equity if you are refinancing an existing mortgage.
The question then becomes, why would you ever choose to use FHA financing? There are actually many really good reasons why you would have to.
When FHA is Your Only Option
FHA insured mortgages are often the best, and sometimes the only choice for some homebuyers in specific situations. The most common reasons include:
- 1.5% higher down payment is simply not possible
- Debt to income ratios exceed 45% of your income
- You do not have sufficient reserves at time of closing
- Lower credit scores cause higher closing costs
- Shorter waiting period after Bankruptcy, short sale or foreclosure
In cases where an FHA insured mortgage is your only option for buying your primary residence, I am proposing that you look at it as the first step, or a temporary solution to a short term problem, an “investment” if you will.
FHA as a 5 Year Plan
If you must use an FHA insured mortgage, time is everything. You may need time to wait out a bankruptcy, short sale or foreclosure. Or you may simply need enough time to pass so that your home’s value increases 1.5% so that you can refinance using Conventional financing.
Regardless for the reason, think of your FHA mortgage as a 5 year plan to get you from point A, which is homeownership, to point B, which is the removal of permanent mortgage insurance.
With purposeful planning, and a 5 year plan, you can now consider taking advantage of a FHA 5/1 ARM at interest rates that are almost 1% lower than a 30 year fixed in today’s market.
When you look at using your FHA loan as a bridge to put you in a better position down the road, your new perspective can unveil many great options that you may not have otherwise considered.
When you consider that a “healthy” equity growth in a normal real estate market is between 5-7% a year, that 5 year window may very well put you in a position to completely remove your FHA mortgage insurance after 5 years.
I’m not sure if we’re in a normal market at this point, especially since 2013 resulted in an average of almost a 30% increase in equity on average for the State of California, but I am saying that I think we’re looking at an improving market in which 5-7% equity growth is not unexpected or unreasonable.
But what if you don’t have 20% equity within 5 years? This is where your 5 year plan really starts to pay off!
Private Mortgage Insurance Options
There are major differences between private mortgage insurance and FHA mortgage insurance premiums that make PMI as the clear and undisputed winner when put head to head.
Mortgage Insurance Premiums are based on Loan to Value – FHA mortgage insurance will go from 1.35% to 1.30% if you have 10% equity (minimum 90% loan to value), however, PMI is reduced for every 5% equity step.
If by the end of 5 years you are only at 85% Loan to Value, your typical mortgage insurance premium would be .39% with a 620 credit score, while FHA requires a 640 credit score, and will still charge you 1.30% – AND it is still permanent.
Let’s look at a real life example of how this would affect your payment:
- Loan Amount = $300,000
- FHA MIP 1.30% x $300,000 = $3,900 (year) divided by 12 = $325 (month)
- PMI .39% x $300,000 = $1,170 (year) divided by 12 = $97.50 (month)
Broadview Community Access (BCA) – If you income (borrowers only) is less than 140% of the area median income, your PMI rate is reduced even further to .33%, which will reduce your monthly PMI payment to $82.50.
In addition to the reduced mortgage insurance, homeowners that meet the BCA income limits also have a cap on closing costs and fees regardless of property type (condominiums usually have higher closing costs), loan to value, or credit scores.
PMI is Only Required for 2 Years – After which a new appraisal can be ordered, or if the principal balance is paid down to 80% loan to value based on the last appraisal, you can petition your lender to have it removed.
I know I sound like a broken record, but FHA Mortgage Insurance is……you guessed it, permanent!
Lender Paid Mortgage Insurance (LPMI) – Conventional financing allows for a Lender Paid Mortgage Insurance premium that essentially is rolled into the price of your interest rate.
Borrowers that choose LPMI should do so carefully, and make sure you consider all of your options, because by increasing your interest rate to avoid PMI, you are basically paying Private Mortgage Insurance for the life of the loan (until you sell or refinance).
On the plus side of LPMI, by converting non-tax deductible mortgage insurance into tax deductible mortgage interest. There is a silver lining to this small cloud.
Working with a Creative Lender
When you’re in the hands of a professional that truly is looking out for your best interest as a homeowner, you have the ability luxury of being presented with all of your possible options and are empowered with the ability to make more informed decisions.
What some may consider to be a high risk move, taking a 5/1 ARM instead of a 30 year fixed, can turn out to be a blessing as you have the ability to make calculated financial decisions, and begin earning equity on your home sooner than you thought.
As a direct lender in California, we pride ourselves in being on the cutting edge of creative financing solutions. When I say “creative” I mean that we know our guidelines, and we know how to fight through the hurdles of complicated situations that others may not have the experience or patience to figure out.
If you would like to explore your refinancing options, you can either ask questions or leave comments below, shoot me an email directly, or give us a call anytime.
Our phone number go to our cell phones, and we are available when you have a question. Don’t be afraid to leave a message, I promise we will get back to you in a timely manner.