Potential homebuyers looking for lower MI costs for FHA loans in 2020 are likely to again be disappointed, even as the capital strength of the FHA's Mutual Mortgage Insurance Fund (MMIF) rose to a level last seen in 2007. FHA is mandated to have a minimum reserve of 2% against losses; for the 2019 year, the reserve was 4.84%, more than double the required amount.

Despite the greatly improved solvency of the MMIF, there are no plans to lower upfront or annual MIP costs or allow for the termination of mortgage insurance. In late 2019, HUD Secretary Ben Carson told HousingWire that ""We want clearly for the MMI Fund to be to robust," noting that at times in its history the reserve ratio has been as high as 6%.

With the record-long economic expansion likely getting long in the tooth, it's probably a prudent fiscal move to keep building reserves in advance of the next downturn, even if it is to the chagrin of homebuyers and homeowners.

Although the cost of an FHA-backed mortgage probably won't fall in 2020, access to funding may continue to improve as lenders to reduce or remove so-called "overlays", where an individual lender will require a higher credit score than the minimums that the FHA requires. Borrowers with less-than-stellar credit should shop around for these more aggressive lenders.

Add lower down payment and credit requirements to the mix, and the fact that these federally-insured loans are assumable, and FHA mortgages are an attractive option to many borrowers.

Carla Blair-Gamblian, a home loan consultant for Veterans United Home Loans in Columbia, Missouri, says that FHA loans will always have a place in the market whether their costs rise or fall.

"Not everyone can qualify for a conventional loan, so comparing [conforming loans] to FHA loans across the board may not yield the best picture of what loan product is best," she says.

Here are the advantages of FHA mortgages in 2020:

Lower credit score and down payment requirements

The FHA requirements for credit score and down payments are far lower than for conventional loans. Borrowers can technically qualify for an FHA loan with credit scores of at least 580 and a down payment of just 3.5 percent, according to HUD. Borrowers with a 10% down payment may be eligible with a FICO score as low as 500.

”While an FHA-backed mortgage with FICO 580 is theoretically available to borrowers, many lenders add 'overlays' on these minimum requirements,” says Keith Gumbinger, vice president of HSH.com. “Loans with the lowest credit scores tend to default at a much higher rate, and lenders are afraid that if they issue too many loans that later fail, HUD will no longer allow them to write FHA-backed mortgages.”

Chris Fox, president of F&B Financial Group in St. Louis, says that borrowers must have credit scores of at least 620 or 640 to qualify for most conventional loans. Fox also says, though, that this is a bit of a misleading benefit. He says that not many lenders will approve any loan, conforming or FHA, for borrowers with credit scores under 620.

FHA mortgage rates

FHA mortgage rates are typically lower than mortgage rates on conforming loans. FHA Borrowers with credit scores of 660 will often qualify for the same interest rate as would conventional borrowers with a score of 740, says Blair-Gamblian.

Closing costs

FHA loans allow sellers to pay up to 6 percent of the loan amount to cover buyers' closing costs, says Tim Pascarella, assistant vice president with Ross Mortgage Corporation in Royal Oak, Michigan. In conventional loans, sellers can only pay up to 3 percent.

"For a lot of homebuyers, that's a big benefit," says Pascarella. "A lot of buyers, especially first-time buyers, can save enough money for a down payment, but then they have nothing else. An FHA loan allows sellers to contribute more to closing costs."

FHA loans are assumable

FHA borrowers have yet another advantage over conventional borrowers: FHA loans are assumable. When it comes time to sell, buyers can take over sellers' existing FHA loans instead of taking out new mortgages at whatever the current mortgage rate is at the time. This is especially advantageous in a rising-rate environment.

"In an environment of rising interest rates, [an assumable loan] can give sellers an advantage over their neighbors," says Dan Green, a loan officer in Cincinnati and author of TheMortgageReports.com.

Assuming an FHA loan isn't always simple, though. While buyers will have to meet all the typical mortgage requirements, they may need a much larger down payment depending on the seller's equity.

If the original mortgage balance was $200,000 and the buyer assumes the loan at a balance of $160,000, the buyer must come up with $40,000 in cash to reach the original balance. The buyer might have to take out a second loan to come up with that figure, which may or may not negate the benefit of a lower interest rate.

Despite the numerous advantages, there are also downsides to FHA mortgages in 2020.

FHA mortgage insurance premiums

The biggest downside of FHA loans has long been the costs associated with the upfront and annual mortgage insurance premiums.

The upfront mortgage insurance premium is 1.75 percent of the loan amount. That's $3,500 on a $200,000 mortgage loan. Although you can pay it out-of-pocket, this cost is usually added to the principal balance of your loan. So your loan amount is actually $203,500.

Then, there are annual mortgage insurance premiums to consider. Unlike Private Mortgage Insurance (PMI), which has a range of costs depending on the borrower's credit score and down payment, FHA Mortgage Insurance Premiums (MIP) go by down payment only. Borrowers with less than a 5% down payment are charged 0.85% of the outstanding loan amount each year, while borrowers with more than a 5% down payment are charged 0.80% per year for loans with terms greater than 20 years. For a borrower with a $200,000 loan and just a minimum 3.5% down payment, this means an MIP of over $143 per month. For a borrower with great credit, that's about $40 per month more than a similar conventional loan.

Annual MIP rates are lower for borrowers who are taking out 15-year FHA-backed mortgage loans. Borrowers putting less than a 10% down payment are charged 0.70% of the loan amount each year, and those with more than a 10% down payment are charged 0.45% of the loan amount each year.

In both cases, FHA MIP are much higher for borrowers who look to take out "jumbo" FHA-backed mortgages in high-cost markets.

FHA mortgage insurance for the life of the loan

With conventional mortgage loans, borrowers don’t have to pay for private mortgage insurance if they come up with a 20 percent down payment. Conventional borrowers can even request that private mortgage insurance be dropped once their mortgage balance falls to 80 percent of the value of their home.

With FHA loans, borrowers who closed their loans after June 3, 2013 must make mortgage insurance payments every year for the life of the loan, no matter how much equity they accrue.

"The only negative of an FHA loan is its cost," says Pascarella. But if a solid credit score and down payment are a stretch for you, an FHA loan might be your only option.

(Image: Karen Roach/iStock)

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