When you take out a mortgage and have a down payment of less than 20% of the home’s value, you typically have to pay private mortgage insurance (PMI). But if you’re securing a Federal Housing Administration (FHA) loan, you’re not off the hook. In this case, you’ll have to pay FHA mortgage insurance. This helps the lender lower its risk in case you default on the loan. But how much does it cost, what are the terms and is it canceable? Below, we explain the ins and outs of FHA loan insurance.
What Is an FHA Loan?
FHA loans are among the easiest mortgage loans for which to qualify. They give individuals with less impressive credit scores and minimal amounts of savings the ability to take out loans and buy their dream house without having to wait for their finances to improve. In fact, FHA loans are available even to those who have declared bankruptcy.
In many ways, FHA loans offer the best possible deal for people without much financial standing. Besides their lax policies on qualification, FHA loans have additional advantages over conventional loans. For example, they include a very small down payment requirement (3.5%). FHA loan also offer assumability, the ability when selling your home to transfer the financial arrangements and have the new buyer assume the outstanding debt you have on the mortgage.
There is a cost, though, for taking out a loan with this much leniency. Typically, borrowers whose down payments come to less than 20% of the home’s price must pay mortgage insurance. This is to ensure, as is the case with conventional mortgage loans, that the lender will get its money back in the event that the borrower defaults. And it’s no different with an FHA loan.
What Is FHA Mortgage Insurance?
In general, mortgage insurance exists to protect the lenders from losing their money if the borrower defaults on the loan. The vast majority of conventional mortgage loans will require insurance solely if the borrower’s down payment is less than 20%. With an FHA loan, on the other hand, mortgage insurance is mandatory on all loans. That’s because defaulting is more likely among these borrowers with less reliable credit scores and not as much in savings.
If you find yourself in a financial situation where an FHA loan is your best bet, you should prepare to grapple with the unavoidable premiums that are attached. If you’re looking for a mortgage loan that allows for a low credit score, you need to pay this insurance premium as part of the deal.
What Is FHA Mortgage Insurance Premium (MIP)?
FHA loans offer an amount of wiggle room and forgiveness when qualifying for a mortgage that conventional loans simply do not. But this looseness comes with a price. The FHA insures the loan, and borrowers must pay this insurance. Lenders are only willing to partake in the less certain business of lending money to individuals with lower credit scores because FHA insurance lessens the risk.
While every situation is unique, FHA loans of all kinds require the homebuyer to pay two different mortgage insurance premiums. The first is called an upfront premium. As its name suggests, this premium requires the borrower to pay 75% of the insurance premium amount right when the loan is issued. Secondly, borrowers must pay an annual insurance premium. This premium varies in cost from 1% to 45%. It is largely determined on the term of the mortgage, which—like conventional mortgages—may amortize anywhere from 15 to 30 years after being issued. The cost of annual premiums also depends on the amount doled out in the loan and the initial loan-to-value ratio. Despite what the name would suggest, you pay the annual premium in monthly installments. Neither of these forms of premiums is optional. But given your financial situation, the benefits that come from FHA loans may far outweigh the costs.
Can You Cancel FHA MIP?
FHA loans offer solid benefits, especially for people who otherwise would not be eligible for a loan. But there are reasons people may be swayed to cancel their FHA loans as a means of stopping the insurance premium payment. Simply put, sometimes the premiums that occur every month can become too cumbersome to pay on time. Indeed, in such cases, it is possible to cancel your FHA mortgage insurance.
However, it may not be as easy as canceling a conventional mortgage insurance plan. The primary way to get out of an FHA MIP is to request cancellation after meeting certain requirements. These include having paid the loan for at least five years (if you have a 30-year loan.) For 15-year loans, there is no minimum. Another benchmark taken into consideration for those who wish to cancel the insurance plan is that the loan balance is at or below 78% of the last FHA-given value. If you have met these requirements (which can take over a decade) and still wish to cancel, your lender is legally required to comply.
It’s important to note that you can only cancel your FHA MIP only if you had or applied for an FHA loan before before June 3, 2013.
FHA Mortgage Insurance vs Private Mortgage Insurance (PMI)
Another way to cancel your FHA mortgage insurance is to refinance it into a conventional loan. In many cases, this is the most cost-effective method to use. By refinancing, you’re able to use your home’s current value instead of its original, likely lower value. Even more, PMI has several draws that may encourage you to switch to a conventional mortgage. Unlike with FHA loan insurance, you only have to pay conventional PMI for two years. After that, you can cancel it. FHA mortgage insurance is not cancelable, and you must pay it for at least 10 years. Jumping ship from an FHA with FHA mortgage insurance to a conventional mortgage with PMI can also be a solid strategy to lessen your monthly expenditures. That’s especially helpful if you are attempting to save for additional purposes, such as paying off student loans.
The bottom line is that conventional loan PMI is typically much less expensive than FHA MIP, not to mention much easier to cancel.
FHA mortgage loans can be invaluable if you need a loan but don’t qualify for a conventional mortgage. Still, the hefty monthly pay requirements can certainly be a deterrent. That’s especially true considering your home’s actual value and your other monthly bill obligations. The insurance exists for the lender, not the borrower. So if it isn’t worth it in your specific financial situation, strongly consider your options before signing the dotted line. For instance, maybe it’s worth it to wait until your credit score improves to attempt to take out a loan for a new home. To better understand your options, find a professional financial advisor with SmartAsset’s free matching tool in your area to fit your specific needs.
Tips for Buying a Home
- Ensure that your credit score is in a good place. When you have a high, stable credit score, you can become eligible for lower mortgage rates, which translates to lower monthly payments. And who wouldn’t want that?
- Reach out to a financial advisor to figure out how homeownership will impact your finances in the long-term. You’ll want to be sure that you can buy a home without having to sacrifice other financial goals down the line. A prime matching tool like SmartAsset’s SmartAdvisor can facilitate this conversation. SmartAdvisor will help you find a financial advisor who meet your needs, in your area, on your budget. You’ll be asked a few short of questions about your finances, and then the program will narrow down your options to three excellent fiduciaries nearby. This program lets you find a good fit with minimal effort and no cost.
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