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Insurance Or Interest Rates?

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Posted On: 01/16/2013

Question:

Rather than finance with an FHA mortgage, a lender has instead proposed that we buy with a conventional loan and 5 percent down. The down payment would be a little larger but there would be no mortgage insurance. Which is the better deal?

Answer:

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With an FHA mortgage, borrowers must pay an up-front mortgage insurance premium (MIP) at closing, equal to 1.75 percent of the mortgage. In addition, there is an annual MIP usually equal to 1.25 percent of the outstanding loan balance. The annual MIP is paid out in monthly installments.

With an FHA loan, you need to pay a 3.5 percent down payment. With a conventional loan, you need 20 percent down – unless you obtain private mortgage insurance.

In this case, there is no separate cost for mortgage insurance even though you are only being asked for 5 percent down. How is this possible?

The magic is in the term “separate” cost. It's not that there is no mortgage insurance or no insurance cost. Rather, to get conventional financing at 5 percent interest with "no mortgage insurance," the lender charges a higher rate of interest – in other words, the lender self-insures and charges the borrower more interest to cover the cost.

Which is the better loan? There are several questions to ask:

First, are there points for either loan? If yes, how much?

Second, how do closing costs compare?

Third, how do the interest rates line up?

Fourth, what are the monthly mortgage payments for principal, interest and mortgage insurance (if any) for each loan?

Fifth, by any chance is the “conventional” loan also a "portfolio" mortgage – a loan not to be re-sold in the secondary market by the lender? If yes, is there a prepayment penalty?

This is a case where either mortgage option can work – but as always, shop around and compare lender offers.

Peter G. Miller is the author of The Common-Sense Mortgage and a veteran real estate columnist. Have a question? Please write to peter@ctwfeatures.com.

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