June 12th, 2015 7:09 AM by Jackie A. Graves, President
Conventional loans are crème de la crème of the mortgage market. This loan type
offers the best possible terms and fees as well as relatively sustainable
long-term affordability. However, those who come to the table with little
equity and lower credit scores may find that a conventional loan costs them
more than other alternatives. Here’s how to know if you need to explore your
A conventional loan is a mortgage originated by banks, lenders,
and brokers across the country and sold on the primary mortgage market to
Fannie Mae and Freddie Mac. This type of loan offers the best terms and rates
due to its mass appeal and large-scale availability. However, this mortgage
type also contains what’s known in banking as risk-based pricing—a
premium commensurate with the risk of the consumer’s financial
With a conventional mortgage loan, a borrower’s credit
score is the
biggest driver of cost.
If your credit score is between 620-679, you can expect to see
higher costs when:
Other factors that affect the price and rate of a mortgage
include: occupancy, property type, loan-to-value, and loan program.
So let’s say your home-buying scenario looks like this:
Due to the lower credit score, it would not be uncommon to see
an interest rate on this type of scenario approximately 0.375% higher than the
average 30-year primary mortgage rate.
Also, when there is less than 20% equity or down payment (so 80%
or more of the home price is being financed), the lender requires the borrower
to pay a mortgage insurance premium of approximately 110% of the loan amount on
an annualized basis. The borrower’s credit score also factors into the mortgage insurance
premium amount for a conventional loan—the lower your score, the more you’ll
pay in mortgage insurance.
For someone with a 630 credit score in this case, that might be
$4,587 per year, which would be $382 per month in mortgage insurance.
However, with a 700 credit score, the interest rate could be
0.25% higher than the primary market rate and the mortgage insurance premium
would be approximately $3,127 per year—or $260 per month.
This is why it pays to have a good credit score when applying
for a conventional loan. So if you expect to buy a home in the next year, now
is the time to check your credit scores and credit reports and get yourself on
a plan to build your credit. A lender can give you guidance on the best steps
to take, too. (You can get your free credit report summary on Credit.com,
updated every month so you can track your progress.)
Often, you can raise your credit score simply by paying
down credit card debt (this calculator can show
you how long
it would take to pay off your credit card debt)—though of course it all depends
on your individual credit history. Ask your mortgage professional if they offer
a complimentary credit analysis with their credit provider. Most brokers and
direct lenders offer this service. By having the mortgage company run this
analysis, you can see how much more your credit score could increase by taking
specific actions. Generally, a good rule of financial thumb is you keep your
credit cards to no more
than 30% of the credit limits per credit card.
You may also want to consider putting more money down when
buying a home to help offset a lower credit score.
Or, you may want to change gears and go with a different
mortgage loan program. An FHA loan could be another viable route in keeping
monthly mortgage costs affordable.
A loan insured by the Federal Housing Administration (FHA) used
to be considered the most expensive mortgage available. That dynamic changed in
early 2015, when the FHA announced it was reducing its annual mortgage
insurance premiums to a fixed 0.80 premium, regardless of loan size or credit
Comparing an FHA loan to our conventional mortgage loan scenario
above, the FHA does not discriminate on credit score the way a conventional
loan does and the mortgage insurance premium on FHA loans is constant. There is
no sliding scale based upon credit score like there is on the conventional
side. The FHA loan of $417,000 would generate a monthly PMI payment at $278 per
month, a whopping $100 dollars per month lower than the conventional loan for
the lower credit score.
Granted, an FHA loan does charge an upfront mortgage insurance
premium of 1.75% usually financed in the loan, but the effect of the payment
would only change by approximately $30 per month, meaning the FHA loan is
really $308 month, making the FHA loan a lower cost monthly alternative
for the lower credit score scenario.
Other FHA loan facts:
If you are in the market for a mortgage and are trying to
refinance or purchase a home, consider working with your loan officer to
qualify on as many loan programs as
possible upfront. Taking this approach can also allow you cherry-pick
which loan is most suitable for you considering your payment, cash flow, and
home-equity objectives within your budget.
This article was written by Scott
Sheldon – To view the original article click here