Home Buyers Could Save Hundreds Thanks to New Rule

At a time when homes are so expensive, that's a good thing.

Mortgage lenders tend to impose different rules when it comes to buying a home. One rule is that lenders will commonly want at least a 10% down payment at closing (though some conventional mortgage lenders will go lower).

But coming up with 10% down can be a challenge for first-time home buyers without existing home equity to tap, and also, for low- or moderate-income buyers who don't have tons of money sitting around in a savings account. And that's where FHA loans come in.

FHA loans are mortgages that are backed by the Federal Housing Administration. The upside of taking out an FHA loan is that you can purchase a home for as little as 3.5% down at closing. Plus, FHA loans tend to have lower credit score requirements than conventional mortgage loans.

But there's a downside to taking out an FHA loan, and it's having to pay mortgage insurance. But going forward, the cost of that is looking to be less expensive thanks to a new rule.

Home buyers are finally getting a break

Between elevated housing prices and higher mortgage rates, many prospective home buyers today are struggling with affordability issues. FHA loans help solve the issue of not having a lot of money to put toward a down payment. But they don't necessarily address the problem of affordability. In fact, if anything, it can be argued that they add to it by requiring borrowers to pay a mortgage insurance premium on an ongoing basis.

The purpose of mortgage insurance is to protect the lenders who give out FHA loans. Since borrowers tend to have lower credit scores and commonly bring less money to the table at closing, lenders take on more of a risk when writing these loans. So mortgage insurance helps compensate for that risk -- at buyers' cost.

But on Feb. 22, the Biden administration announced that FHA mortgage insurance premiums are dropping from 0.85% a year to 0.55%. That change alone will save an estimated 850,000 home buyers an average of $800 on home financing costs this year alone.

Should you take out an FHA loan?

FHA loans are a good option for borrowers who can afford monthly mortgage payments but don't have a lot of funds available for a down payment on a home. But some experts argue that if you can't afford to put down a larger down payment on a home, you probably can't afford a home to begin with.

That logic is understandable, but also questionable. It may be that you have a really good job with a decent salary, but due to other financial circumstances, such as having to pay off debts, you don't have a lot of savings. If a lack of down payment funds is your only barrier to owning a home, then an FHA loan might be a good solution.

That said, even with the aforementioned change, mortgage insurance premiums for FHA loans aren't going away. They're simply getting less expensive.

If you wait on buying a home and save up a 20% down payment, you can avoid mortgage insurance (known as PMI) on a conventional mortgage. The result? Lower monthly housing costs all-in. And so while FHA loans are a good option for certain borrowers, it does pay to consider the benefits of taking out a conventional mortgage you don't have to pay any sort of insurance on.