FHA mortgage insurance
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The Federal Housing Administration insures certain loans to protect the lender and allow them to offer you a better deal. Known as FHA mortgages, these come with several benefits, including less restrictive eligibility requirements. However, the advantages come at the expense of the ongoing cost of FHA mortgage insurance.
What is FHA mortgage insurance?
FHA loan mortgage insurance is a fee charged by lenders on loans with lower down payments. This additional payment you make reduces their financial loss in the event that you default on your mortgage. Also known as FHA mortgage insurance premium (or MIP), you’re first charged an upfront premium that’s included as part of your closing costs. After that, you’re charged for the FHA insurance each year of your loan.
It’s important to note that this isn’t homeowners insurance, which is meant to protect you against financial loss in case your home or personal property is damaged by a covered event. Your mortgage insurance premium protects your lender in the event you stop making mortgage payments. It allows them to recuperate some of their losses in case of default.
Is FHA mortgage insurance required?
FHA mortgage insurance is required by lenders as part of the approval requirements. That’s because this type of loan is designed for borrowers with less cash saved for a down payment and potentially lower credit scores. When taking out an FHA loan, the minimum down payment is typically just 3.5% of the purchase price, according to the U.S. Department of Housing and Urban Development (HUD). On top of that, the minimum credit score is just 580, although you could even qualify with a 500 credit score if you make a 10% down payment.
Pros and cons of FHA mortgage insurance
FHA loans come with higher mortgage insurance premiums than average, but they also have easier eligibility requirements for borrowers. Here are a few of the advantages and disadvantages of this type of mortgage.
- Lower down payment
- Minimum credit score is just 500 to 580
- Competitive interest rates may balance extra cost
- Must pay MIP both at closing and annually
- Must pay for the entire loan period if your down payment is less than 10%
How much does FHA mortgage insurance cost?
There are several factors that determine the cost of your FHA mortgage insurance, including the loan term, loan amount and the size of your down payment. All FHA mortgages come with an upfront mortgage insurance premium of 1.75% of the loan amount. So if you buy a $300,000 house, you’ll pay an additional $5,250 at closing.
Determining your annual premium is a little more complicated. The percentage you pay varies based on your base loan amount, your loan-to-value ratio and whether your mortgage term is greater than 15 years. Expect to pay anywhere between 0.80% and 1.05% each year. FHA mortgage insurance lasts 11 years if you make at least a 10% down payment. But if your down payment is less than that, you’ll have to pay the annual MIP for the life of the loan.
How does FHA mortgage insurance work?
FHA loan mortgage insurance is charged at the beginning of your loan and then on an annual basis. But you don’t have to pay that annual premium directly. Instead, the amount is divided up and evenly distributed across your 12 monthly payments. Say your loan amount is $300,000 and your MIP rate is 0.80%. Your annual premium would be $2,400. Divided over 12 months, that would add $200 to your monthly payment.
How to get rid of FHA mortgage insurance
If you didn’t make a 10% down payment, you are not stuck with your FHA MIP. And even if you did put down that amount, 11 years is a long time to pay this extra fee. In order to get rid of FHA mortgage insurance, you can apply to refinance into a different mortgage.
You may get a lower rate with a different type of loan, especially if your credit score has improved since taking out your original mortgage. Additionally, if you’ve built equity or have extra cash to pay down some of your mortgage, a conventional refinance may not come with any new mortgage insurance at all.
How to reduce FHA mortgage payments
If you purchased your home with an FHA loan before June 3, 2013, you may be able to drop your MIP when you reach 20% equity in your home. But mortgages originating after that date are held to the standard of either waiting 11 years for the MIP to come off, or not being able to drop it at all. In those cases, you may be able to reduce your mortgage payments with one of two types of refinances:
FHA Streamline Refinance
You won’t lose your mortgage insurance premium with an FHA Streamline Refinance, but you may qualify for a better interest rate. If your credit score has improved or rates have dropped since you took out your loan, you may be able to qualify. Plus, the paperwork is less burdensome and you may be able to get out of an appraisal as well.
Conventional Loan Refinance
If you have at least 20% equity in your home, a conventional loan refinance could help you drop that mortgage insurance altogether. Just make sure the closing costs and new interest rate make sense when compared to the savings.
FHA mortgage insurance versus PMI
While you pay a mortgage insurance premium (MIP) for a mortgage from the FHA, PMI (or private mortgage insurance) is what you’ll pay with a conventional loan and less than a 20% down payment. PMI costs range between 0.25% and 2% of your loan balance. There are no upfront costs at closing, and instead you’ll pay an annual rate, which is spread across your monthly mortgage payments. Once your loan-to-value reaches 78% (meaning you’ve paid off 22% of your purchase price), your PMI automatically drops off.
Is FHA mortgage insurance tax deductible?
Yes, mortgage insurance is currently tax deductible. However, you must itemize your deductions in order to qualify for this tax benefit. If you take the standard deduction as many people do, this wouldn’t apply to you.
- FHA mortgage insurance is charged upfront and annually.
- It may drop off after 11 years or could last the life of the loan.
- Refinancing options provide you the opportunity to drop FHA mortgage insurance.
- PMI is different from MPI, as it is a loan not backed by the FHA.
An FHA mortgage gives many people a faster path to home ownership. However, it’s important to understand the cost that mortgage insurance adds to your closing costs and monthly payment, as well as how long this fee lasts. While you do have options down the road that allow you to negate the need for FHA mortgage insurance, it typically involves a refinance. Research the cost of having FHA mortgage insurance vs saving longer for a higher down payment to avoid the added cost.