Staying on my theme of credit this month. I’m building on a post from my colleague in late August about credit scores. Last week I gave some real world numbers of the impact credit scores can have on mortgage payments and mortgage insurance.
This time I want to focus on how to avoid the worst parts of lower credit. What I mean is this… Is there a way to avoid the worst impact of a higher rate and/or higher mortgage insurance? Can we reduce the increase of a payment due to higher rate and/or mortgage insurance?
There isn’t much that can be done to improve someone’s credit score if they have legitimate missed payments OR a thin credit profile. That said, there are some things people can do to reduce the impact on the rate and/or mortgage insurance premiums for those with lower credit scores.
Pay off credit card debt: Let’s say a borrower’s credit score is low because of high utilization of credit card debt (not multiple late payments on credit accounts). A maxed out credit card is a quick way to lower a score, and paying it down/off is a great way to make the score jump. I had a client decide to make a 10% down payment instead of a 20% down payment. He used part of his originally planned down payment to pay off all credit card debt, and his credit scores went from the 660s to the 740s (just like weight loss programs, “results can vary.”) Sure, he now pays mortgage insurance. With a credit score over 740 and 10% down, he paid about $70 per month and got a great interest rate. While paying mortgage insurance is a bummer, the amount he was paying each month on his credit cards was way more than $70 per month AND he saved tens of thousands of dollars over the life of the loan by getting a lower rate.
Avoid store based credit cards: I see buyers get in trouble all the time with this. Sure getting an extra 10% off a purchase is nice, but it could cost you. Most store credit cards come with a low limit. Why? Because in a pinch, the first credit cards that don’t get paid are the ones to Kohls, Best Buy, Macy’s etc. These stores do not want a high balances to get reached, so they keep the limit down. Let’s say I get a store credit card to an electronics store to purchase a laptop for my child going back to school. If I get a limit of $1500 on this store credit card and the laptop costs $1200, all of the sudden it looks like I am close to maxing out a credit card and credit scores go lower. Credit score models are not based on total limits versus total debt load. It looks at each credit card individually in terms of its utilization. Also, most people forget to pay store credit cards. It happens A LOT. A missed credit card payment is a missed payment whether it is a major credit card or a store credit card.
Make a larger down payment: It doens’t seem like much, but putting more than the minimum down payment can make a big difference on mortgage insurance and also the interest rate.
10% down versus 5%: while the rate is the same, the mortgage insurance payment drops by 40% in my examples from last week AND the borrower will not be required to even pay the mortgage insurance as long as it is for someone making the minimum down payment.
20% down: if paying off debt isn’t an option (meaning, legitimate late payments and/or collections), then this gets rid of mortgage insurance entirely. The rate will still be higher, but it avoids the double whammy of higher rates and higher mortgage insurance premiums.
40% down: yeah, that is a large down payment. Why am I pointing it out? When putting 40% down, a borrower gets the same rate whether they have a 660 credit score or an 800+ score. The rate is only slightly worse (say 0.250% higher) for credit scores in the 620-659 range.
15 year fixed loans: The rate for 15 year loans are the same whether a borrower has a 620 credit score or one over 800. Yes, you read that correctly. Maybe a large down payment isn’t possible. Perhaps paying down credit card debt isn’t an option. This could be. Also if making less than a 20% down payment, the difference in mortgage insurance is about $110 more per month for a 679 credit score versus a score over 760. Borrowers avoid a much higher rate, avoid the bigger brunt of the mortgage insurance increase AND get the benefit of paying off their home in half the time versus a 30 year loan.
Co-Borrower on the loan: this one sounds silly, but it’s true. Let’s say the borrower has a significant other they were not planning on being on the loan. Perhaps they are self employed and do not show a lot of income. Perhaps they are the primary caregiver for their children and earn no income outside of the home. The reason does not matter. If their credit score is the same (or better) than the primary borrowers, the mortgage insurance premiums each month drop by roughly 20% simply by having two people on the loan (the mortgage rate is still the same).
FHA loans: when all else fails, this is a great option. I’ve said FHA loans until now for two reasons. One is the up front mortgage insurance premium rolled into the loan amount (meaning borrowers do not pay this out of pocket at closing as it is added to the loan itself) and the mortgage insurance is permanent. The advantages of an FHA loan is the rate will be better for someone with a credit score under 680 (versus a conventional loan), and the mortgage insurance each month would be less. If this isn’t a “forever” home, then the word “permanent” isn’t as scary. We could do a compare/contrast to see if an FHA loan is beneficial to a borrower’s monthly cash flow.
VA loans: for those who qualify, there is no monthly mortgage insurance, and the rate isn’t as bad for those with lower credit scores compared to conventional loans.
There you have it. Some ways to mitigate the impact of lower credit scores when purchasing a home. I know this can all be overwhelming. If you are looking to buy a home in Georgia, need a mortgage, and have some credit problems, contact me today to get started. We can take a look at your situation and see what we can do to mitigate the impact on your home loan.
Last month my colleague Rodney Shaffer evaluated a recent Zillow study on credit scores. His post focused on what makes up a credit score. This post will focus more on the impacts of the credit score.
We all know a lower credit score leads to a higher interest rate. A real world example is a rate about 0.750% higher for someone with a 760 credit score versus someone with a score under 680. In the mortgage world, once a score is at/above 760, it doesn’t matter anymore. They get the same rate at 760 versus 800+.
When you factor the rate difference on a loan of $300,000, using today’s rates, the payment is roughly $140 more per month. Over 30 years, this is $50,000 more of interest paid for having the lower rate.
Sadly, it doesn’t stop there. If mortgage insurance is required, it’s even worse. Using the same $300,000 loan amount, someone with a 760 credit score with 5% down would pay about $60 per month. If the credit score dropped to 679, the mortgage insurance payment would increase to $260 per month… $200 more per month.
Combined a borrower with a 760 credit score would pay roughly $350 less per month if they got a loan at $300,000 with 5% down versus someone with a credit score just under 680.
There is a big difference in rates and mortgage insurance once someone goes below 680. With a credit score of 680, the rate difference is just 0.375% (payment difference on the loan is $80). Mortgage insurance is about $160 per month. So you can see the range of paying $180 more if the credit score is in the upper 600s versus $350 more per month once the credit score drops below 680 (and gets worse the closer a borrower gets to a 620 score).
It’s a lot and frustrating. These numbers are also why I recommend clients do an FHA loan once their credit scores fall below 680. Next time, I’ll focus more on ways to help your situation in the event of a lower credit score.
Wanting to talk credit and getting a loan in the state of Georgia, contact me today to get started!
I am going to pick up right where my colleague Rodney Shaffer left off with his recent blog post. Buyers do not need 20% down to purchase a home. Honestly, we should do a post on this topic monthly because we hear it monthly from clients who think they way more down than is necessary to purchase a home.
Rodney’s recent post focused on an article he came across saying “20% is best” when buying a home. What the article doesn’t detail is home appreciation is rapidly outpacing one’s ability to save. So a $300,000 home with 20% down won’t be the same home when the $60,000 is saved years from now.
I’m focusing on a recent study by the National Association of REALTORS stating almost half of would be home buyers believe they need a larger down payment than is actually required. About 35% of would be buyers believe the down payment needed is more than 15%. Another 10% of would be buyers believe the minimum down payment requirement is more than 20%.
You do not need 20% down in order to purchase a home:
Conventional loans require as little as 3% down. Meaning, a home at $600,000 could be purchased with as little as $18,000.
Ideally buyers put 5% down for conventional loans as the interest rate is better and the monthly PMI is lower. On the same $600,000 home, the down payment would be $30,000.
FHA loans only require 3.5% down. The max FHA loan limit in metro Atlanta is just over $470,000. Meaning, a purchase price just under $490,000 with 3.5% down (roughly $20,000) is all that is needed.
I know there is an aversion to paying monthly Private Mortgage Insurance (PMI). This is required when purchasing a home with less than 20% down. I get it, yet, PMI payments aren’t necessarily the end of the world. Let’s look at two recent clients:
One client purchased a home around $300,000 and had 15% to put down. Instead of waiting to save an additional $15,000, they put 15% down and will pay $26 per month in PMI for just a few years.
Another client purchased a home around $400,000 and put 10% down. Instead of waiting to save an additional $40,000, they are paying just over $40 per month in PMI for several years.
When you compare the monthly payments on PMI to continuing to rent, not getting appreciation for a home you own, locking in an interest rate now, trying to save more and more money… paying PMI isn’t as bad as it seems.
If you’ve made it this far into the post – thank you for reading! If you do not remember anything else from this post, please remember (and tell all your friends), buyers do not need 20% down to purchase a home!
Speaking of purchasing a home, if the purchase is in the state of Georgia, contact me today! I can get you well on your way to owning a home!
A recent National Association of Realtors (NAR) economist blog noted that 24% of first-time home buyers obtained FHA financing in January, while 59% obtained conventional mortgage financing. This is very interesting as it contrasts the picture painted in my blog post from September 2019. That post noted that 75% of Millennial home buyers obtained FHA financing. While not all first-time home buyers are Millennials, the recent data still appears to be a significant change from only about 18 months ago.
FHA mortgages once attracted many first time home buyers with a 3.5% minimum down payment. But beginning in 2014, home buyers could obtain conventional loans with only a 3% down payment. FHA loans also appeal to home buyers with lower qualifying credit scores. Conventional interest rate pricing charges higher interest rates for lower credit scores. Because FHA pricing places less emphasis on the borrower’s credit score than conventional loans, FHA pricing was often more attractive to buyers with credit scores less than 700, especially when those buyers could only make a small down payment.
Note that “standard” conventional loans with a 3% down payment require the borrower to pay a higher interest rate and mortgage insurance premium as compared to 5% (or more) down conventional loans. But conventional mortgage giants Fannie Mae and Freddie Mac began offering special loan programs (called Home Ready and Home Possible, respectively) to home buyers whose annual income falls below a threshold (currently about $65,000 in the Atlanta area) and with credit scores of 680+. With these programs, 3% down conventional loans become very competitive with FHA loans for buyers who qualify.
When a buyer qualifies for the Home Ready / Home Possible program discounts, they can save money in two ways as compared to FHA financing. First of all, conventional loans do not require up-front mortgage insurance. FHA loans require a 1.75% up front mortgage insurance premium that is typically rolled into the loan amount. Secondly, when the borrower’s equity reaches 20%, the conventional loan mortgage insurance can be cancelled, even when the borrower initially made only a 3% down payment. Borrowers who use FHA mortgages with less than a 10% down payment must pay monthly mortgage insurance premiums for as long as they own the mortgage. The monthly FHA insurance premium is 0.85 for all loans with less than 10% down payments. That is about $177 per month on at $250,000 mortgage. The fact that such a large insurance premium is permanent makes many buyers consider conventional loans more favorably.
Are you considering your first home purchase? Be sure to explore all the loan programs available to you, including conventional and FHA mortgages. Give me a call and I’ll help you compare your options to determine which will give you the lowest total payment, considering both the interest rate and the mortgage insurance components.
As discussed previously, using an FHA loan to buy a home makes sense for home buyers with relatively low credit scores and limited down payment funds. FHA loans offer very attractive pricing for these home buyers.
Interest rates have now fallen to their lowest level in three years, so it may be time for current FHA mortgage holders to consider a conventional mortgage refinance. The interest rate savings may not be huge, but changing from FHA mortgage insurance to private mortgage insurance could bring significant financial benefits.
I’m working with a couple now (we’ll call them Jack and Diane) who bought their home in 2017. At that time, their qualifying credit score was in the mid-600’s and they had just enough cash for the FHA minimum down payment. This was an ideal scenario for an FHA mortgage.
Fast forward to 2019 – their credit scores have increased and home appreciation in their neighborhood has given them more equity. A conventional loan now makes sense for their updated situation. They can refinance to a new interest rate that is just 0.25% less than their current rate. Normally such a small monthly savings, by itself, does not justify the cost of refinancing.
In addition to the interest rate savings, they will also save money every month with lower mortgage insurance payments. Switching from their FHA loan to a conventional loan will lower the mortgage insurance monthly premiums by about $120. Their total monthly savings equal $160, and their refinance has a break-even point of just over two years. Considering the interest rate savings plus the mortgage insurance savings makes their refinance worthwhile.
An added benefit is that their new private mortgage insurance will cancel in a few years (unlike the FHA insurance which is permanent), increasing their monthly savings to about $200. So, Jack and Diane will realize this bonus savings in just a few years.
Ultimately, home buyers who used an FHA loan two or three years ago may reap big rewards from a conventional refinance now, assuming their property value has increased.
Ron moved into your neighborhood in the last three years or so. At the neighborhood Halloween party, ask Ron if he has heard of an FHA mortgage. If he replies, “Yes, that’s the type of loan I have,” ask him if he would like to lower his monthly payment. Then connect Ron with me. We will quickly determine whether moving to a conventional mortgage can help Ron financially.
There are some interesting facts and observations in an August article documenting survey results from Millennial home buyers. Here’s a link to the full study from lendedu.com. 1,000 people aged 23 to 38 participated in the survey. Here are some survey results:
58% of respondents say they own their own home.
83% of these home owners obtained a mortgage to buy their home.
75% of these mortgage holders obtained a FHA loan.
16% is the average down payment percentage for the survey respondents.
To me, it is very surprising to me that such a high percentage of these home buyers used the FHA program, especially given the relatively high down payment percentage reported. What I also find surprising is how the author treats FHA loans vis a vis the private mortgage insurance component of conventional mortgages.
Let’s look at the basics of FHA mortgage insurance (“MI”) vs. conventional (private) mortgage insurance (“PMI”). FHA charges a 1.75% up-front MI. On a $300,000 loan, that charge is $5,250. Assuming a Millennial average 16% down payment, FHA charges a 0.80% monthly MI premium, which equals $200 per month. And for this loan, the borrower must pay the monthly MI for 11 years.
For PMI on conventional loans, there is no up-front fee. So our $300,000 mortgage holder is better off by $5,250 to start. The PMI premium is based on the combination of down payment and the borrower’s credit score. Let’s assume that a Millennial buyer (we’ll call her “Anna”) has a 680 credit score. I calculate Anna’s monthly PMI premium at 0.26% or $65 per month. In addition, the conventional loan PMI will cancel sooner than FHA MI, so Anna will pay conventional loan PMI for less than half the time she would pay FHA loan MI.
Summarizing this example, Anna with a 680 credit score would reap the following mortgage insurance benefits of choosing a conventional loan vs. FHA: (1) Anna saves $5,250 by not having the up-front FHA MI premium rolled into the loan amount; (2) Anna saves $135 per month with the lower PMI rate vs. the FHA MI rate; and (3) Anna stops making mortgage insurance payments way sooner. And Anna’s PMI payment will be even lower if her credit score is in the 700’s. From a mortgage insurance perspective, the conventional loan seems like a much better deal.
The author praises the use of FHA mortgages, then later makes the following statements about private mortgage insurance:
“PMI should be avoided as it will usually cost the homeowner between 0.5% to 1% of the full mortgage amount….”
“…it is not great that so many are also paying for PMI as a result of less-than-optimal down payments…”
Such blanket negative statements about PMI concern me. In our example, and many examples where the borrower has a strong credit score and can make a 10% or more down payment, the numbers often favor conventional loans. FHA loans are often better when the borrower’s credit score is low or the borrower can only make a down payment of 10% or less.
The key lesson here is to consult a professional mortgage lender (I suggest that this guy for Georgia home buyers) to run the numbers for both FHA and conventional loans. Then choose the best option given your circumstances.
Now let’s change our buyer scenario. Both Jack and Diane want to make offers on a home, but this time they have 10% to put down. (Curious about a smaller down payment? Take a look at the prior scenario with a 3.5% down payment.) They still have the same qualifying credit scores of 680 for Jack and 795 for Diane.
With Jack’s 680 credit score, his monthly payment for a conventional loan (principal, interest, and mortgage insurance “MI”) would be $1,514.30. For a FHA loan, his payment would be $1,452.29. Given Jack’s credit score – even with the 10% down payment – FHA still delivers a better price, even though FHA loans have the draw backs of the up-front MI and the permanent monthly MI (assuming Congress does not change the law).
In this scenario with Jack’s 10% down payment, the mortgage insurance falls off after 11 years (even if Congress doesn’t act). Meaning, the FHA loan becomes even more attractive now and into the future.
With Diane’s 795 credit score, her monthly payment for a conventional loan would only be $1,391.24. Her FHA loan payment would be $1,452.29. (Note that it is the same as Jack’s payment, even though Diane’s credit score is over 100 points better.) In this case, Diane can now save money by using the conventional loan. The conventional loan has the best pricing from the beginning, and it provides the PMI cancellation benefits mentioned in the previous post.
With this example, one can definitely see how FHA loans do not have the same impact when it comes to the interest rate, mortgage insurance, and monthly payment versus conventional loans. Even with such a large gap between the credit scores (680 versus 795), the payment on the FHA loan is the same.
Ultimately, every client situation is unique. For some borrower circumstances (e.g., self-employed, buying a condo, high debt to income ratio, etc.), we may recommend one loan option because the buyer has a better chance to win approval, even if the payment winds up being slightly higher.
Do you know someone planning to buy a home in Georgia? If they have questions, connect them with me. I love helping people understand their mortgage options and helping them determine the best approach to financing a home purchase.
I’ve thrown up a posts over the past couple of months (here and here) about potential changes for condo purchases using FHA loans. How about a change on FHA loans that is beneficial for everyone!
A new bill working its way through Congress would make mortgage insurance for FHA more like mortgage insurance for conventional loans.
Currently, FHA mortgage insurance is permanent unless the buyer makes a 10% down payment. When making a down payment as large as 10%, often buyers use a conventional loan. Maybe there is a case where someone still wants to do an FHA loan (for example, a foreclosure 3 years ago is OK on FHA loans but not OK for conventional loans), but often 10% down means a buyer is using a conventional loan for their purchase.
With FHA’s current permanent monthly mortgage insurance, it makes FHA loans much less competitive with conventional loans. The new bill looks to change this situation.
If passed, the bill would change the cancellation date on FHA mortgage insurance from “until the loan is paid in full” (meaning permanent for the life of the loan) to when the loan balance is 78% of the homes original value. Meaning, the mortgage insurance is no longer permanent.
The current set up with mortgage insurance on FHA loans really isn’t fair to the home buyer. They are way over charged paying mortgage insurance for the life of the loan, and the change could make FHA loans are more viable alternative for buyers making the minimum down payment on a home purchase.
Can’t decide if an FHA is right for you? Contact me and we’ll find out! If you are buying a home in the state of Georgia, I can also get you prequalified and ready to make an offer on your new home.
Now let’s take a look at conventional mortgage details. (Click here to review FHA loan details. And here is a link to the Home Ready program changes.)
In general, conventional loans are less forgiving of credit issues than are FHA loans. Conventional loans require longer wait times after derogatory credit events like foreclosure or bankruptcy. And the borrower’s credit score has a much greater impact on conventional loan pricing versus FHA loans. The lower one’s credit score, the higher the interest rate. In some cases, a credit score 100 points lower could cause the borrower’s interest rate to increase by almost one percentage point.
Ultimately, this makes conventional mortgages less attractive to borrowers with lower credit scores and more attractive to those with higher credit scores.
Conventional loans do not require up-front mortgage insurance, but private mortgage insurance (“PMI”) is required for down payments less than 20%. PMI rates vary based on the borrower’s credit score and down payment. For the same loan amount, the monthly PMI will be dramatically different for a 690 credit score borrower making a 5% down payment vs. a 780 credit score borrower making a 15% down payment. PMI is not permanent. It automatically terminates when the borrower’s loan balance reaches 78% of the original contract price or appraised value (whichever is lower). And, in certain circumstances, the borrower can request PMI cancellation prior to reaching the 78% threshold.
Borrowers can obtain a conventional loan with a minimum 3% down payment. This often only makes sense when the borrower’s credit score is 720 or higher. With a lower score, the PMI cost for a 3% down loan can get pretty expensive. We often recommend that conventional buyers make a 5% or more down payment to keep PMI costs lower.
Another advantage of conventional loans is the maximum loan amount. While FHA caps out at a purchase price of around $390,000 using the minimum down payment, conventional loans can go higher. How much higher? How about a $500,000 purchase price with a 3% down payment. That is about 25% higher than the FHA maximum.
In the next posts, we will compare some hypothetical home buyer scenarios to determine which loan is best – conventional or FHA. Do you know someone who wants to buy a Georgia home? Please refer them to me. We Dunwoody Mortgage professionals ask important questions to determine if we can help our clients make slight changes (down payment amount, paying down a credit card balance, etc.) that help them save money with a better interest rate and / or lower PMI premium. We work hard to deliver excellent service and pricing to our customers, and our consistently positive reviews show our clients are pleased with our work.
As recently reported in The Mortgage Blog, mortgage interest rates have dropped to their lowest level in over two years. The last time rates were consistently this low was just before the 2016 Presidential election. For people who purchased homes since then, it may make sense to refinance now. So how do you decide if a refinance is right for you?
I read one article from a major think tank stating you should refinance for a rate that is a specific amount lower than your current rate. I believe that is a bit simplistic and you should crunch numbers in more detail. I recommend comparing the financial benefits against the cost of refinancing – the total amount you can save each month versus the refinance cost.
With a rate / term refi, you will save by lowering your monthly interest payments and, possibly, by lowering or eliminating private mortgage insurance (PMI) payments. I recommend you focus on the dollar savings. A 0.5% interest rate change on a $100,000 loan will save you much less per month than the same interest rate change on a $400,000 mortgage. Eliminating or reducing PMI payments can provide significantly lower monthly payments. To eliminate PMI, you must must have 20% equity. Perhaps your home’s value has increased since you bought it. You can capture this higher value as equity in the new loan using a new appraisal value. If the appraisal shows you have greater equity, even if it’s less than 20%, you may see your PMI payment reduced, perhaps substantially.
How do I analyze the savings? I estimate a new monthly payment based on the lower interest rate and potential PMI changes and compare this rate versus their current payment. Then I divide the refi closing cost by the monthly savings to get a “break even” point. If the monthly savings break even on the closing costs in three years or less, I typically recommend that the client pursue the refinance. Why three years? It seems most people have a general idea of their plans for the next three years or so. Anything further than that becomes a little murkier. I’m currently working with a client who has a $335,000 loan. I estimate a refinance will save her $150 per month and will “break even” in about 22 months. That seems like a wise financial move to me.
Another option to consider is a cash out refinance. Is there a home project you want to do? Perhaps a kitchen or bathroom renovation? I have clients using their home equity and lower interest rates to take cash out for a project, and still have the same payment (or even a better payment) than they have now.
Do you know someone who bought a Georgia home in 2017 or 2018? Ask them what they would do with an extra $100 per month. Then refer them to me. I’ll run the numbers to determine whether refinancing is a wise move.
Clay Jeffreys is a Mortgage Consultant with Dunwoody Mortgage Services and a writer for “the Mortgage Blog.” If you would like to be a guest writer for "the Mortgage Blog" please contact Clay for details.
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