Most first-time homebuyers are a little stretched financially, so they want payments as low as possible at the beginning. With FHA's adjustable rate mortgage (ARM), the initial interest rate and monthly payments are low, but these may change during the life of the loan. FHA uses the 1-Year Constant Maturity Treasury Index (1 Yr CMT the most widely used index, to calculate the changes in interest rates. An index is a measure of interest rate changes that determine how much the interest rate on an ARM will change over time.
The maximum amount that the interest rate on your loan may increase or decrease in any one year is 1 or 2 percentage points, depending upon the type of ARM you choose. Over the life of the loan, the maximum interest rate change is 5 or 6 percentage points from the initial rate, again depending upon the type of ARM you choose. The advantage of an ARM is that you may be able to afford more house because your initial interest rate will be lower, as will your payment.
How do FHA loans compare to subprime loans?
Subprime loans are loans designed for homebuyers who don't have a credit history or can't qualify for a regular or prime loan. Lenders charge a much higher interest rate on subprime loans because the risk that a homebuyer may not make their payments is higher. Because FHA insures the lender against this risk, the interest rates on FHA loans are generally among the lowest in the market. Most subprime loans carry interest rates at least 3 percentage points higher than FHA. On a $100,000 mortgage, this means the monthly payment for a subprime loan would be over $200 a month higher than on an FHA loan.
Most subprime loans are also ARMs, where the interest rate can change a lot and greatly increase your monthly payments. Most FHA loans are fixed rate loans where the mortgage payment always stays the same. If you have an FHA ARM loan, the rate can't go up by more than one or two points in a year. The fees associated for processing a subprime loan are also generally higher than on an FHA loan.
Finally, most subprime loans carry a heavy prepayment penalty that you must pay if you want to refinance your loan to a lower interest rate. These penalties typically cost the borrower thousands of dollars. There is never a prepayment penalty on an FHA loan. You can refinance at any time and not worry about paying any penalties.
Unfortunately, because they don't know these facts, many home buyers who could qualify to buy a home with a fixed FHA rate only apply for subprime loans. Don't make that mistake! Check out our FHA loans before settling for a subprime loan.
How do FHA loans compare to conventional loans?
Conventional loans usually require a larger down payment. And, if you have less than perfect credit you may not qualify for many conventional loans even if the >interest rates and fees are comparable to FHA. The best thing to do is compare the cost of the conventional loan to an FHA loan line-by-line. What are the fees on each? What is the interest rate? How much is the mortgage insurance on each? How much down payment is required? For some borrowers, a conventional loan may be less expensive. For many others, it will be more expensive than FHA.
Do you have to buy mortgage insurance on an FHA loan?
Yes. There is an up front mortgage insurance premium equal to 1.5% of the loan amount that is paid at settlement. In most cases, this mortgage insurance premium is included in your loan amount, so you are really paying it over the life of the loan. In addition, on loans with a term of greater than 15 years and a loan-to-value ratio of 90% or greater (meaning you are borrowing more than 90% of the value of the home), you will pay an annual mortgage insurance premium of 0.5% of the loan amount in monthly installments.
Up Front Mortgage Insurance Premium
Mortgage amount: $100,000 X 1.5% = $1,500 @ 6.5% for 30 years = $ 9.48 per month
Annual Mortgage Insurance Premium
Mortgage amount: $100,000 X 0.5% = $ 500/12 months = $41.67 per month
Total Mortgage Insurance Premium $51.15 per month
Most loans require mortgage insurance when your down payment is less than 20% of the sales price. On conventional and subprime loans, mortgage insurance is provided by private companies. Whether private mortgage insurance is less than, equal to, or more than FHA loan insurance will depend upon the loan program and your qualifications.
Compare the cost of FHA over the life of your loan and how much it costs monthly to subprime and conventional types of loans. With the protection you get with FHA - it's a very good deal. To learn more about FHA loans please contact an FHALoanCorp representative at toll free 888.447.7314 or click here * to submit your info and have a representative contact you.