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My husband and I worked diligently to pay down our debt, ensure our credit scores were favorable, and have a chunk of cash saved in the bank. At the time, we were renting and found that we were quickly outgrowing our small, two-bedroom house. We searched for a new house to rent and realized that the renters' market in our area greatly favored the renter rather than the tenant. Prices were outrageous.

After some budgeting and deliberation, we decided the best decision financially was to purchase a home. We made the three-mile drive to our credit union to inquire about a mortgage. They congratulated us on our superb financial planning at such a young age and proceeded to offer us a mortgage loan at the prime rate. The only stipulation we did not count on? They wanted a minimum of 20% down. We had saved only 10%.

The credit union gave us two options: save for a little longer or look into a FHA insured loan. With this type of loan, we only had to put down 3.5% on our home. The excitement returned, and we embarked on our hunt for the perfect house. Six months later, our home was secured, and we even had sellers pay our closing costs. We put 5% down, so we had extra money to contribute to furnishing our new place. Our dreams of homeownership had come true – but not without a cost we had not anticipated.

While the FHA loan was attractive with its low down-payment, we later found out that an extra fee for Private Mortgage Insurance (PMI) was tacked onto our monthly payment. The PMI fee was low so we did not really worry about it, but when we calculated it over the life of our mortgage, we realized we could have purchased a decent mid-sized sedan with that money. In hindsight, we realized that saving the extra 10% and going with the conventional loan might have been our better option.

Here's a general breakdown: Let's say your credit is good enough to get the prime FHA mortgage rate of 3.25% and you are looking to purchase a house at $150,000. Your down payment, excluding closing costs, is $7,500. Your borrowed amount is $142,500. Each lender makes the decision of what percentage rate to charge for PMI based on the buyer's credit score and loan amount. If your credit score is around 720, PMI will run about $85.50 per month on a fixed-rate, 30-year mortgage. Not so bad right? Well that $85.50 per month added to the life of the mortgage costs you $30,780. PMI can be cancelled once the loan to value ratio is below 78%, but even then you are still paying for PMI for at least 17 years – generally longer.

Still, the FHA loan has its benefits. The money saved by putting 20% down on home and avoiding PMI payments might not be a priority, and that is where FHA mortgages come into play. Borrowers with less than perfect credit can obtain a home with an FHA mortgage. Also, lenders who offer FHA mortgages will consider rolling the cost of any renovations into the life of the loan in case a borrower chooses a home that needs some work. Even the PMI insurance comes in handy, because having your loan insured by FHA makes some lenders lenient when approving a borrower.

The lesson here is to calculate what you're getting into. For some, an FHA loan can be a great opportunity. For us, it might have been wiser to save a little longer instead of jumping into a house. An FHA loan is there for a reason, but just because it's available, doesn't mean you should use it.
 

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