We received a call from a potential customer, referred to us by a real estate agent we work with, who was looking to get qualified for a home price of about $400,000. He had just received a large inheritance and was debating on exactly how much to put down on the home. He had a figure in mind but wanted to run the numbers. Here is how the numbers played out at his figure of $250,000 down:

Pretty good payment for a $400,000 house!  Now that we know what it would look like based on the number in his mind, we started to play with the numbers a bit.

First let’s look at how much you can save for every $1,000 you put down.  Through a simple mortgage calculator you can calculate how much $1,000 over a 30 year loan, fixed at 5% will change your monthly payment.  It comes out to $5.37/mo.  What this means is that for every $1,000 you put down your principal and interest payment will decrease about $5.37/mo.  In this example, he is putting $250,000 down or $236,000 more than the minimum (minimum is 3.5% or $14,000).  That means that the monthly principal and interest savings is about $1,267.32 (236 X $5.37).  5% is a great rate and historically very low, so let’s look at some other examples based on average 30 year fixed mortgage rates from Freddie Mac:

• 2009 Average= 5.04% or $5.39/mo per $1,000 down
• 2000 – 2009 Average = 6.29% or $6.18/mo per $1,000 down
• 1972 – 2009 Average = 9.28% or $8.25/mo per $1,000 down

When people see these figures they are normally very surprised how little $1,000 down will impact their payment.  There are certainly other factors to consider though.  Probably the biggest factor to consider is mortgage insurance. Mortgage insurance protects your lender and is required when you put less than 20% down on a mortgage.  There are 2 main types of mortgage loans and the monthly mortgage insurance amounts vary for each:

• FHA – 1.75% Up-Front Mortgage Insurance Premium (Changing to 2.25% Apr 5)
  • .55% of loan amount divided by 12
• Conventional
  • 5.00 to 9.99% Down Payment = .94% of loan amount divided by 12
  • 10.00 to 14.99% Down Payment = .62% of loan amount divided by 12
  • 15.00 to 19.99% Down Payment = .38% of loan amount divided by 12

These mortgage insurance factors add a level of complexity to calculating the savings of putting more down.  Let’s look at the monthly payment of principal, interest and mortgage insurance at different amounts down:

Based on this table you can see that by putting down an additional 5%, or $10,000, you save more than just the $5.37/mo, calculated in the first example. The difference between Conventional 5% and Conventional 10% is $109.51 instead of the $5.37/mo per $1,000 down calculation of $53.70. This is because of the drop in the MI factor dropping from .94% to .62%.

Getting back to our example with this gained knowledge we know that a 20% down payment should be the least amount the customer should consider.  This will allow him to avoid paying mortgage insurance and provide him the biggest bang for his buck.  From there it became a decision of personal choice and calculating whether to put money down or invest with a better return on his money.

Rather than redo all the calculations on this question, I will direct you to check out Get Rich Slowly who wrote a post titled Ask the Readers: Is it Better to Invest or Prepay a Mortgage.  The great thing about this post is that it not only gives you great resources for making this decision but also gives you the calculations and opinion of others.

My customer decided that even though he may be able to get a better rate of return in the stock market or other investments he still wanted to put the full $250,000 down.  Ultimately you are the one that needs to determine what is best.  Mathematical calculations will likely show it is better to invest than to buy down the mortgage but the emotional side of having the security of a low monthly mortgage payment can weigh heavily on this decision.

Lending A Hand

Scott Wynn

The Wynn Team

• 90 Day Flipping Rule Waiver (Feb 1)
• Up-front Mortgage Insurance Premium Increase from 1.75% to 2.25% (Apr 5)
• 10% Down Payment Required for Credit Scores < 580 (Summer)
• Max Seller Contributions Decreased from 6% to 3% (Summer)

Here are the details on each of these changes:

90 Day Flipping Rule Waiver (Feb 1)

Posted on Lending a Hand on January 15, the 90 Day Flipping Waiver allows sellers who have owned the home for less than 90 days to sell to qualified FHA buyers.  Prior to this waiver the seller was required to own the property for 90 days before selling to an FHA buyer.

Up-front Mortgage Insurance Premium Increase from 1.75% to 2.25% (Apr 5)

As a part of HUD’s interest in eliminating risk on their FHA mortgage loan product, they have increased the up-front mortgage insurance premium from 1.75% to 2.25%.  This was merely the first step in changing the mortgage insurance premiums.  The next step will be to take legislative action to increase the maximum monthly mortgage insurance premium which will allow a reduction of the up-front premium.  We will have to wait and see what happens on this.

To the average customer this means that instead of paying an additional, one time fee (paid at closing or financed over the term of your loan) of 1.75%, the fee will now be 2.25%.  In terms of numbers let’s look at an example.  On a $200,000 FHA mortgage that means the cost now (1.75%) would be $3,500.  With the change to 2.25% the new cost would be $4,500 or $1,000 more in this example.  For most FHA buyers, this will increase their payment about $5-7/mo since most opt to finance this cost into their mortgage.  Not a huge impact, but still an extra $1,000 on the loan that isn’t there now.

10% Down Payment Required for Credit Scores < 580 (Summer)

Although not yet passed, this is likely to go into effect early Summer after the required process completed by HUD.  The change will require any customer with a credit score less than 580 to put 10% down on FHA loans instead of the normal 3.5%.  Currently there are very few, if any, FHA lenders willing to approve a customer with a credit score below 580 so very few potential customers will be impacted by this change.  What may happen, however, is that more FHA lenders will allow for lower than 580 score since they will be putting 10% down.  Another one we will have to wait and see what happens.

Max Seller Contributions Decreased from 6% to 3% (Summer)

The same process required on the 10% down change must occur before this change can go into effect.  Currently sellers can contribute as much as 6% towards closing costs, prepaids and up-front mortgage insurance premiums on FHA mortgages.  This change will reduce that to 3%.  Conventional mortgage loans have been capped at 3% so this isn’t something that will likely impact most people.  Those that this will impact is the lower purchase price buyer.  Let me show you why in two examples:

FHA Mortgage, 30 Year Fixed, 5% Rate, $100,000 Purchase Price with 3.5% Minimum Down

• 1% Origination Fee = $965
• Typical Closing Costs (excluding origination fee) = $1,300
• Typical Prepaid Expenses = $1,000
• Typical 3rd Party Fees = $850
• TOTAL = $4,115 (4.12%)

FHA Mortgage, 30 Year Fixed, 5% Rate, $300,000 Purchase Price with 3.5% Minimum Down

• 1% Origination Fee = $2,895
• Typical Closing Costs (excluding origination fee) = $1,300
• Typical Prepaid Expenses = $2,960
• Typical 3rd Party Fees = $850
• TOTAL = $8,005 (2.67%)

In these two examples, one at a low price and the other at a higher price, the percentage of total closing costs is much higher on the lower purchase price (4.12%) compared to the higher purchase price (2.67%).  The reason this happens is because most closing costs stay the same.  The only things that change are the origination fee (because it is a percentage of the loan amount) and the prepaids (because it varies based on the value of the home).  Under this new rule, if you were the $100,000 buyer and wanted to ask the seller to pay for all of your closing costs and prepaids you would be limited to 3% or $3,000 leaving $1,115 left for you to pay.  If you were, however, the $300,000 buyer you could ask for the full 3% and have money left over (which, by the way, is not allowed on FHA).

Those are the changes that are already approved to go into effect or will likely be changed later on in 2010.

Lending a Hand

Scott Wynn

The Wynn Team

Photo provided by magicaldp on Flickr

Nobody wants mortgage insurance.  The only reason people get mortgage insurance is to provide the opportunity to buy a home without a 20% down payment.  People went as far as doing 80/20 (80% 1st mortgage and a 20% second mortgage) financing to avoid paying mortgage insurance, even if the payment ended up a little higher.  Why?  Because the second mortgage interest was tax deductible, which mortgage insurance was not.  In addition, when you pay on the second, you are at least paying a small portion of the payment towards the principal balance while mortgage insurance does not help reduce the loan balance at all.  With changes to allow mortgage insurance to be tax deductible and the elimination of second mortgage loan options, mortgage insurance has, again, become a popular means to avoiding a 20% down payment.  So, how do you get rid of the mortgage insurance on your loan?  It depends on whether you have an FHA or Conventional mortgage.  VA is not discussed, because VA has no monthly mortgage insurance to be removed.  So let’s look at the differences.

FHA

HUD has made several changes to mortgage insurance on FHA loans over the past year, but it seems they have come to a resolution on what the mortgage insurance will be for the foreseeable future.  Currently the monthly mortgage insurance cost for all FHA borrowers is .55% of the loan amount per year.  You then take that amount and divide it by 12 to get the monthly amount due with each mortgage payment.  Here is an example:

$200,000 loan amount

.55% Monthly Mortgage Insurance = $200,000 X .55% (.0055) = $1,100/yr

$1,100 Yearly Mortgage Insurance divided by 12 months = $91.67/mo

FHA does have some unique considerations when it comes to mortgage insurance.  Typically, with Conventional mortgage financing, if you put 20% down you do not have to pay mortgage insurance.  FHA does not follow this same rule.  No matter how much you put down on a FHA mortgage, monthly mortgage insurance will be required for a minimum of 5 years.  If you are able to put 20% down, Conventional financing will be the way to go.  The only reason you may go with FHA compared to Conventional with 20% down, is due to the more lenient guidelines FHA has compared to Conventional.  Another consideration is that point in which mortgage insurance must be removed.  With FHA financing, monthly mortgage insurance is required to be removed once the current mortgage balance compared to the original purchase price is 78%.  Let’s look at an example:

$200,000 purchase price

$197,700 loan amount (based on calculations including down payment and financing up-front mortgage insurance)

$200,000 (original purchase price) * 78% (the point MI is required to be removed) = $156,000

This means that as soon as the mortgage balance hits $156,000 through normally monthly payments or pre-payment on your mortgage, the monthly mortgage insurance payment will be removed.  If you make your minimum payments each month, with no additional principal payments, with the example above, it would take 152 months (12 years and 8 months) to get to that point.

Conventional

Conventional mortgage insurance is obtained through private mortgage insurance companies and each have their own rules, rates and guidelines.  Your lender should be able to assist you with this.  I pulled up the rates for Mortgage Insurance in the Denver, Colorado Metro area and the rate for a 5% down Conventional mortgage is .94%.  The method for completing the calculation is the same as with FHA.  Here is the same example, this time for Conventional Mortgage Insurance:

$200,000 loan amount

.94% Monthly Mortgage Insurance = $200,000 X .94% (.0094) = $1,880/yr

$1,880 Yearly Mortgage Insurance divided by 12 months = $156.67/mo

Now that we understand the difference between the monthly premiums on FHA and Conventional mortgage options, what are the differences in when it can be removed?  Conventional has the same requirement as FHA does at the 78% mark of the original purchase price compared to the current mortgage balance.  Conventional offers some additional options for the removal of mortgage insurance that FHA does not. Conventional, unlike FHA, will consider the difference between the current market value and the current mortgage balance.   Here is an example to explain.

$200,000 original purchase price

$190,000 original loan amount (based on 5% down)

After 5 years of minimum payments the loan balance would be $177,861

Assuming a 3% appreciation rate, after 4.5 years, the value would now be $231,855

$177,861 (current balance) divided by $231,855 (current value) = 76.7%

With this example, the borrower could request that the conventional mortgage lender complete a property appraisal (at the borrower’s cost) to determine if they agree with the value.  Assuming the point of 78% has been reached between the current value and the current balance, the borrower may request that the MI be removed.  The mortgage lender is not required to remove the MI until the point mentioned above, however does have the authority to remove it, if they choose.

Why wouldn’t a Conventional mortgage lender remove it at the point the current balance compared to the current balance is at 78%?  My theory is that they anticipate that the value would go down and/or you might default.  To eliminate that risk, the lender may require the mortgage insurance continue to be paid until a greater gap is achieved or values are continually going up.

Hopefully, now you understand the differences between mortgage insurance on FHA loans compared to Conventional loans as well as when the mortgage insurance can be removed.  Another option, of course, would be to refinance once you have 20% or more equity in the home.  Consider the costs of refinancing when determining whether this options makes sense.

Lending a Hand,

Scott Wynn