In the good old days (say, before the end of 2008), home buyers with a down payment less than 20 percent had lots of options -- get a second mortgage, get a piggy-back loan, take on mortgage insurance until home equity reached 20 percent, or go with an FHA mortgage. In most cases, FHA loans were the least popular choice because they involved upfront mortgage insurance premiums.
Today, however, FHA is the mortgage of choice for many. Its upfront mortgage insurance premiums have been reduced (although its monthly charges were increased). However, the main contributor to the popularity of FHA loans, even for those with down payments of more than 5 percent, has been the lack of available private mortgage insurance.
Mortgage insurance approval is harder to come by
Until recently, an automated approval courtesy of Fannie Mae's Desktop Underwriter or Freddie Mac's Loan prospector software was good enough to make a mortgage a done deal. If the property appraised at the sales price you were good to go. However, if the down payment was less than 20 percent, you also had to be approved for a mortgage insurance policy. And nowadays, that's where things get sticky.
Mortgage insurers often have stricter guidelines than lenders. And most of those have to do with the value, condition and location of the property involved. In addition, mortgage insurance guidelines are frequently tougher on loans that come through non-retail channels (for example, mortgage brokers) than they are for loans that come in through direct lenders like banks. Insurer Genworth requires a credit score of 740 on a 95-percent loan submitted by a broker, but only 680 if it comes from a direct lender.
Finally, even when an insurer's guidelines allow a loan to be approved in theory, lenders nationwide report that getting an actual approval is nearly impossible -- especially if you are trying to buy a condo or a home in a troubled state like California, Florida, or Nevada.
That's why your lender may recommend FHA
After submitting applicants with good credit, solid employment histories, and healthy finances over and over to mortgage insurers, only to have these applications shot down again and again, lenders have become gun-shy (or maybe just practical). And so they recommend FHA loans to those with less than 20 percent down to reduce the chance of disappointing their clients and irritating their real estate agents.
What should you do?
When you compare FHA and conventional mortgage rates in California or other distressed states, insurance is a factor. Have your loan agent run the numbers and see which option will cost you less -- an FHA plan or a conventional loan.
If you decide to go for a conventional loan, understand that you may have trouble getting mortgage insurer approval and let your loan officer know that you understand that and are okay with it. Prepare to jump through some annoying hoops with the understanding that in the end you may have to take an FHA loan anyway. Finally, make sure that your real estate offer includes provisions for the possibility of needing FHA financing and the possibility of needing to extend the time it takes to close.