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.
