Planning on getting a home loan anytime soon? Before you do, you should know that there are two types of loans that are inherently higher in cost than their traditional mortgage counterparts — and we’re not talking subprime or private money, either.
Bottom line, if your credit score is below 680 or you have credit blemishes or little equity, it can drive up the cost of a mortgage. This is why it’s so important to know what your credit score is before you shop for a mortgage. (One helpful — and free — resource is Credit.com’s Credit Report Card, which gives you your credit score and breaks down the components of your credit report to show you where you’re doing well, and which areas of your credit you need to work on to build your credit.)
FHA loans and conventional loans are the meat and potatoes of today’s mortgage market. These product types represent the lion’s share of nearly all loan applications. So why are these so pricey? Simply put, because a lower credit score means higher risk, the lender will charge a lower-credit borrower more to insure the loan against default. Let’s look at how it works out.
FHA Loan Nuts & Bolts
An FHA loan has two forms of mortgage insurance (this is what insures the lender against your defaulting on the loan). One is an upfront mortgage insurance premium (UFMIP) financed and amortized over the loan term, which is based on 175 basis points of the loan amount. An additional monthly mortgage insurance premium is also applied using 135 basis points of the loan amount.
On a $400,000 home loan for example, that’s an extra $486 per month for the benefit of carrying a loan insured by the Federal Housing Administration.
Calculating the Mortgage Insurance Payments
UMFIP: $400,000 loan amount × .0175 (UMFIP) = $7,000 + $400,000 = $407,000 financed loan amount. This figure determines the principal and interest payment
Monthly Mortgage Insurance: $400,000 × .0135 ÷12 = $450. This monthly premium inflates the mortgage payment by the most.
Conventional Loan Nuts & Bolts
You might think that the conventional loan — the most sought after — is the lowest cost mortgage available, right?
Wrong!
If your credit score is below 700 and you’re comparing mortgage offerings, some lenders won’t tell you that your conventional home loan is going to get very pricey, very fast.
Unlike its FHA counterpart, there is no up-front mortgage insurance premium with conventional financing, just a monthly premium based on a varying range percentage of the loan amount sought. And higher risk (because of a lower credit score) equals higher cost.