FHA Lender Credits are a Cost-Effective Bargain

Posted by on Monday, January 21st, 2013 at 4:19pm.

Federal Housing Authority (FHA) financing is a great option for many buyers, particularly those unable to meet the more stringent down payment and higher credit score requirements of conventional financing. FHA loans offer competitive, low 30-year fixed rates and allow for supporting income from a family member to qualify. But FHA loans carry significantly higher closing costs. One way to offset the increased costs is to take a lender credit in exchange for a slightly higher interest rate. While choosing a higher rate may seem counter intuitive, some borrowers may need help to cover closing costs and even those who don't may consider the exchange a bargain.

FHA loans fall into two categories: conforming loans up to $417,000, and FHA jumbo loans that range as high as $729,750, depending on a given county's set limit. Down payments as low as just 3.5% are accepted on both and the reason challenged borrowers get the best terms is because FHA loans carry mortgage insurance funded by  one-time premiums and the on-going monthly mortgage insurance payments that the borrower is charged. The one-time, Upfront Mortgage Insurance Premium (UFMIP) currently amounts to 1.75% of the base loan. So the charge on a $729,750 loan will cost around $12,770. This FHA fee can be financed by being added to the base loan, but the cost is there nonetheless.

A loan's closing costs are divided into Non-Recurring Closing Costs (NRCCs) and Recurring Closing Costs (RCCs). NRCCs are one-time fees associated with the transaction - lender charges for processing and underwriting, title and escrow fees, including the lender's policy and the owner's policy, fees for pest inspections, appraisals, etc. RCCs are recurring fees that are separate from securing the transaction and include items such as property taxes, hazard insurance, and mortgage interest. Portions of future RCCs must be collected on any loan transaction and these, too, are much higher on FHA loans as the lender will need to establish an impound account.  FHA loans typically mandate impounds, which is the monthly collection of prorated property taxes and hazard insurance. To set up the impound account, they may to collect upwards of 8 months' property taxes as well as 14 months' hazard insurance premium.

Borrowers with limited funds to cover closing cost may consider a lender credit in exchange for a nominal rate increase as an attractive solution. On a loan of $729,750 supporting a purchase price of $756,000, the combined closing costs -after factoring in lender fees, title fees, the FHA's UFMIP, 14 months' hazard insurance premium, 8 month's property taxes, pre-paid mortgage interest, etc. -could potentially run as high as $30,000. Depending on pricing at the time a loan is locked, a nominal rate increase could offer credits of over $20,000 and make the purchase a tenable proposition for the buyer. 

This is not a commitment to lend. Rates and terms subject to change without notice.

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