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FHA Closing Costs - How They Differ From Conventional Mortgages

Jun 24, 2008
FHA Closing costs differ from conventional mortgages by the amount the lender can charge and the amount of insurance coverage homeowners are required to have. FHA mortgages are the last of the government sponsored mortgages. Fannie and Freddie started out as a government charter but privatized over a decade ago. Since FHA is government operated, there are specific safeguards which have been designed to protect borrowers from paying too much closing costs. However, as is the case with most government programs, there's loopholes.

When lenders and brokers close a loan, they all incur cost during the process. These costs are passed along to the borrower in the form of higher rates, or closing costs that are added directly to the closing statement (HUD). In the past, lenders have been known to be very liberal when applying their fees; these extra charges are called "junk fees." Before you apply, you should insist that the lender disclose their fees on a form called good faith estimate (GFE, you can print a blank form from the link below.)

If you look at your GFE you will see a grouping of fees on the left hand side. Each fee is labeled 801, 802, and so on. These are the lenders fees. FHA has strict guidelines pertaining to the fees that lenders are allowed to charge when closing a loan. Unfortunately, they are very open-minded on the amount of discount points and origination points that they allow lenders to charge.

Lenders are allowed to charge one origination point and two discount points plus the "usual and customary" third party closing costs that FHA deems relevant. If you combine those fees with the additional money that the lenders can earn from "marking-up" the interest rate; lenders could make as much as $12,000 profit on a $200,000 loan.

In all fairness, most lenders don't fleece their customers like this, however some do. If you are considering taking out an FHA mortgage I advise you to look at your good faith estimate carefully. If you see discount points listed in the "800" block of numbers do not close your loan. Some lenders will give very compelling arguments as to why they need to charge them, don't believe it. By disallowing the lender to use discount points, you have effectively forced them to keep their closing costs in-check.

Another difference in charges that you will see over conventional mortgages pertains to the insurance each agency requires when taking out the loan. Conventional mortgages (Fannie Mae, Freddie Mac) will allow borrowers to forego the mortgage insurance if the loan is less than 80% of the appraised value. Not so with FHA, when you take out an FHA mortgage you will be forced to have mortgage insurance regardless of the loan to value. The exception is when you take out a 15 year mortgage, if your loan is less that 90% of the value of the home you can forego the monthly mortgage insurance.

Also, FHA charges an up front mortgage insurance premium (MIP). This is a one time, lump sum that is added on top of your loan. The MIP is calculated at 1.5% of the mortgage's loan amount, i.e. a $100,000 mortgage would become a $101,500 loan amount. This premium is refundable on a prorated basis but, the formula that is used to calculate it is stored in the same warehouse that Indiana Jones keeps his worldly treasures.

When you begin to add up the differences between FHA closing costs and conventional mortgages, it would appear that FHA mortgages have the higher closing. However, it really depends on what your specific circumstances are as to whether or not an FHA mortgage is right for you. If you have good credit and a low loan to value, a conventional mortgage is definitely the best road to take. Even if your loan to value is a little high, you may still want to consider a conventional mortgage. A conventional mortgage charges PMI just like an FHA loan does, however it can be easily removed one the home falls below 80% loan to value, unlike FHA mortgage insurance.

On the other hand, if you have average credit and a higher loan to value FHA becomes the clear winner when choosing the most beneficial loan. The most important reason is that FHA is not a credit score driven product. FHA is a common-sense loan, meaning your credit score doesn't have a bearing on your ability to get approved. FHA looks at the property, the income, the job stability and the overall responsibility the borrower has exercised in the last year. Of course there are more guidelines, but you get my point. Not to mention that FHA allows homebuyers to put as little as 3% down when buying a home.
About the Author
Aubrey Clark is a writer and editor for Direct Banc, low interest rate credit card directory, and Lendfast.com, a nationwide home mortgage loan company. He lives and works in Atlanta Georgia with his wife and four children.
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