FHA Mortgage Insurance: What, Why and How Much
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FHA loans help many U.S. consumers realize their homeownership dreams because the loans carry less stringent borrower requirements than those of conventional loans. Still, the lower entry barrier comes at a price — borrower-paid mortgage insurance premiums. Keep reading for a deeper look into what these premiums are, why they exist and how much they could cost you.
FHA mortgage insurance explained
FHA loans are backed by the Federal Housing Administration, which is a subsidiary of the federal Department of Housing and Urban Development (HUD). Because FHA-approved lenders take on more risk — due to the lower credit score and down payment requirements — the FHA imposes mortgage insurance premiums (MIP) on borrowers. In many cases, you’re responsible for these mortgage insurance premiums for the life of your loan. However, there are a few exceptions to this rule, which will be discussed later. These premiums protect the lender in the event of a mortgage default.
That may be less unfair than it first sounds. The FHA guarantees a big chunk of the mortgage you borrow from your private lender. They’re on the hook if things go wrong. Without your mortgage insurance adding a little extra protection, the taxpayer would be picking up an even bigger bill were you to suffer some setback that meant you couldn’t maintain your monthly mortgage payment obligation.
For the sake of clarity in this article, we focus on MIP information for the purchase of a single-family home.
Annual vs. upfront MIP
FHA borrowers have to pay two types of mortgage insurance premiums: annual and upfront. The upfront mortgage insurance premium is charged when you first get your mortgage, and the annual premium is an ongoing obligation you pay every year.
Paying for FHA mortgage insurance
The upfront mortgage insurance premium costs 1.75% of your loan amount. You’ll pay the upfront premium at the closing table. If you’re borrowing $200,000, for example, your upfront MIP will be $3,500 ($200,000 x 1.75% = $3,500). The 1.75% cost applies to most FHA loans, no matter the loan amount or term, except for the following:
- Streamline refinances and some simple refinances
- Hawaiian home lands
- Indian lands
The ongoing, annual mortgage insurance premium, which ranges from 0.45% to 1.05%, is divided by 12 and paid as an addition to your monthly mortgage payment. The cost associated with your annual premium depends on your loan-to-value ratio and mortgage term. Review the MIP charts below for more guidance.
FHA MIP Chart
|FHA MIP Chart for Loans Greater Than 15 Years|
|Base Loan Amount||LTV||Annual MIP|
|FHA MIP Chart for Loans Less Than or Equal to 15 Years|
|Base Loan Amount||LTV||Annual MIP|
|>$625,500||78.01% – 90.00%||0.70%|
Source: FHA Handbook
Difference between MIP and PMI
Mortgage insurance premiums apply to FHA loans specifically, but conventional loans have a similar requirement, called private mortgage insurance (PMI).
Conventional mortgage borrowers must pay PMI when they make a down payment that is less than 20% of their home’s purchase price. Just as with MIP, the purpose of PMI is to protect the lender if you fail to maintain your monthly mortgage payments.
Your credit score and loan-to-value ratio determine the cost of PMI, but the price range may fall somewhere between $30 and $70 per month. Unlike FHA MIP, there is no upfront premium, though you may have the option to pay PMI in a lump sum at closing.
As previously mentioned, in many cases, FHA mortgage insurance premiums are in place for the life of your loan. Private mortgage insurance, on the other hand, can be dropped after you reach 20% equity in your home.
How to get rid of FHA mortgage insurance
Up until 2013, you would generally stop paying the annual mortgage insurance premiums once your average outstanding balance dipped to 78% of the original value of your loan. Since that year, many FHA borrowers have to pay annual mortgage insurance premiums for the duration of their mortgage.
One of the main ways to get rid of FHA MIP is to put down at least 10% at closing. You’ll still pay the premiums, but just for 11 years. Another way to drop it is to refinance into a conventional mortgage, but you must do several things to prepare for a refi, including:
- Be sure your credit history is free from any blemishes that could stop you from qualifying for a refinance.
- Improve your credit score. Most conventional lenders expect a 620 credit score or higher.
- Build at least 20% equity in your home to avoid private mortgage insurance. If your loan-to-value ratio is higher than 80%, you’ll pay PMI as part of your refinanced loan.
Everyone else has to keep paying throughout their loan’s term – often 30 years. Fortunately, the burden becomes less over time as the average outstanding balance falls, owing to monthly payments and potential salary increases, making those premiums increasingly affordable.
FHA mortgage insurance probably won’t bother you much if you’re a first-time borrower. The benefit of making a small down payment and getting your foot on the first rung of the homeownership ladder may outweigh the disadvantage of having to pay mortgage insurance. For some, an FHA loan might be the only way forward.