An FHA mortgage is a great deal for many Americans because they offer substantial credit flexibility and as low as a 3.5% down payment, with very low interest rates. These mortgage loans are guaranteed by the Federal Housing Administration, so lenders are able to offer them to more Americans with lower incomes and credit scores. For nearly nine decades, Americans have been reaping the benefits of affordable home financing with FHA loans that feature competitive interest rates and flexible FHA credit requirements.
Many Home Buyers Finance FHA Mortgage Insurance into Their Monthly Housing Expenses
One of the things you need to understand about FHA loans is the mortgage insurance requirement. With FHA home financing, this insurance is called MIP, but is generally known in the industry as PMI. Below is more information about MIP on FHA loans, as well as more general information about FHA loans. When people are shopping different types of loans it is imperative to consider mortgage insurance premiums or PMI, because they can increase the monthly payments dramatically. It is crucial to analyze home affordability with FHA. In some cases it may make more sense to choose a lender paid mortgage insurance option even if the interest rate is higher. At the end of the day you must consider your total housing expenses, (ie. loan payment, mortgage insurance, taxes and insurance, etc.)
How MIP/PMI Works with a FHA Mortgage
Approved FHA lenders can approve borrowers with many types of credit and income, but all must have mortgage insurance. The FHA loan is required to have two types of mortgage insurance premium. The first is the Upfront Mortgage Insurance Premium and an Annual MIP. The upfront mortgage insurance is 1.75% of the loan amount as of 2023. It is paid at loan closing. So, a borrower with a $350,000 loan will pay $6,125 upfront. This cost can be wrapped into the loan, however. The payment is put into an escrow account set up by the Treasury Department. It will be used to make mortgage payments if you default.
The annual MIP payment is made each month as part of the mortgage payment. The payments will vary depending upon the amount of the loan, how loan the loan is, and the loan to value or LTV. On average, MIP will cost .85% of the loan amount per year. For a $350,000 home, this amounts to $247.50 each month.
Numerous borrowers may hold reservations about paying MIP or PMI, but it undeniably serves a vital purpose that extends assistance to a multitude of Americans. The reality is that a significant portion of the population finds it financially unfeasible to make a 20% down payment on a home, a prerequisite set by the mortgage industry for acquiring a loan without the need for mortgage insurance. In the absence of mortgage insurance, countless individuals would find themselves renting their homes for extended periods before they could accumulate the financial means to make a purchase.
In essence, mortgage insurance, despite representing an additional monthly expense, fulfills the crucial role of enabling individuals to purchase a home with as little as 3.5% down payment in numerous scenarios. By embracing home ownership, these individuals can begin building equity in their homes and relinquish the perpetual cycle of dispensing their financial resources on rental payments. It becomes apparent that homeownership, rather than directing monetary resources toward someone else’s mortgage by leasing a home or apartment, becomes an attainable reality, fostering financial independence and bringing the dream of owning a home within the grasp of a broader segment of the American population.
Once you have 20% equity, you can refinance the FHA loan to a conventional loan in many cases and get rid of mortgage insurance entirely. Note that most new FHA loans issues after mid 2013 do not allow you to cancel MIP even after you reach 20% equity. Read the Guide to Buying a Home with a FHA Loan.
Other FHA Requirements to Consider Before Making an Offer on a Home
Although FHA mortgages are very flexible in terms of qualifying, there still are requirements you must meet. The days of no doc and no income verification loans are over.
First, you must show a steady employment history, which can be shown by working for the same employer for two years. FHA requires your front-end ratio which includes your entire monthly mortgage payment to be less than 31% of your gross, documented income. But some lenders may approve you with up to 40%. And your back-end ratio, which is the sum of all monthly debt obligations, should be less than 43% of your documented gross income.
Self-employed people are also eligible for this government home financing program but should take a measured approach before submitting a FHA loan application online. You just need to show a profitable business for the past two years, by showing tax returns and a profit and loss statement for the current quarter. If you have worked for yourself for less than two years but more than a year, you also can be approved if you show a solid work and income history for the two years prior to becoming self-employed. The self-employed job should be in a related occupation to your previous full-time work.
Approved FHA mortgage companies can approve people with bankruptcies or foreclosures. But you should be at least two years out from the bankruptcy. Also, you should be three years past a foreclosure and show that you are paying your bills on time. You do need to be current on your federal tax payments, but if you have an installment agreement where you are paying reliably, that is fine. It is worth your time to speak with lending professionals in regards to your credentials to get a mortgage pre-approval with FHA.
Generally, the property you finance needs to be your main residence and you should live there. This program is not intended for rental properties, although if you buy an apartment building or duplex and live there, you can get an FHA loan. The lender from which you get the loan must be approved by FHA to lend.
FHA mortgages are recommended for first time house buyers with past credit problems and difficulty coming up with a 20% down payment. But you need to show you have a steady financial situation for at least the past year to be approved.
How to Get Rid of Mortgage Insurance on a FHA Loan
As of 2023, all loans offered under the Federal Housing Administration mandate the inclusion of mortgage insurance, which is technically known as mortgage insurance premium (MIP). While people often colloquially refer to it as PMI, MIP is the accurate term for FHA mortgage insurance. Regardless of your down payment amount, FHA requires MIP, setting it apart from conventional mortgages where you’re exempt from paying mortgage insurance when making a down payment of 20% or more.
It’s important to understand that mortgage insurance plays a crucial role in the lending process, as it offers the lender protection against potential defaults. MIP facilitates homeownership for many Americans, allowing them to transition from renters to property owners more quickly. Nevertheless, the majority of individuals harbor a strong aversion to mortgage insurance costs and actively seek ways to eliminate it.
The following section provides additional insights into FHA mortgage insurance and outlines the strategies for canceling it.
If your FHA loan was secured before July 3, 2013, and your loan-to-value (LTV) ratio stands at 78% or less, it’s advisable to reach out to your lender to formally request the removal of the premium. Generally, this request needs to be made in written form. However, if you obtained your FHA mortgage after July 3, 2013, and your initial down payment was below 10%, you will be obliged to maintain mortgage insurance premium (MIP) for the entire duration of the loan. Only in cases where you made a down payment of 10% or more can you consider removing mortgage insurance. A change in FHA regulations a few years ago eliminated the option to cancel MIP once the LTV ratio reaches 78%.
If you find yourself in a situation where your property boasts 20% or more equity, yet you are still burdened with FHA mortgage insurance payments, the most viable course of action is to explore refinancing into a conventional loan at your earliest convenience. To embark on this journey, you might need to bolster your credit score, alleviate your debt, and improve your debt-to-income ratio. It’s important to note that the majority of conventional loans today mandate a minimum credit score of 620, although your prospects will markedly improve with a higher credit score. Furthermore, demonstrating a consistent payment history across all debts featured on your credit report over the past 12 months will significantly enhance your chances of securing a conventional loan.
Two Types of FHA Mortgage Insurance
To begin with, there exists upfront FHA mortgage insurance, an initial fee collected at the time of loan closing. This upfront premium amounts to 1.75% of the total loan amount. It is typically rolled into the loan balance, although you do have the option to pay it separately during the closing. In the event you decide to refinance your FHA loan within three years of the initial closing, you are eligible for a refund of the upfront MIP that went unused.
The second form of FHA mortgage insurance takes the shape of an annual premium, divided into 12 monthly portions and included within your regular monthly payment. It is essential for prospective FHA loan applicants to be aware that, as of July 2013, the ability to cancel mortgage insurance after your loan-to-value (LTV) ratio drops to 78% or lower is no longer applicable. In such cases, you must maintain MIP coverage throughout the entire term of your loan. Additionally, an annual mortgage insurance premium, varying between 0.80 and 0.85 basis points, is obligatory, contingent on the specific LTV of your loan. The other alternative is to refinance out of FHA and consider a no PMI mortgage.
How to Not Have FHA Mortgage Insurance
The best way to get rid of FHA mortgage insurance is to not have it at all. Try to make a 20% down payment with a conventional loan, but it is true that not everyone can afford to do this. Another option is to get an 80 10 10 loan. This is where you make a 10% down payment, get a mortgage from FHA for 80% of the price of the house, and another for 10%. This will avoid paying PMI.
Some lenders also have an 80 15 5 program. This is where you have to have a 5% down payment, and get a first mortgage for 80% of the price and another loan for 15%.
If you are a military veteran, you can obtain a VA loan that does not have mortgage insurance and has no down payment. You also can enjoy even lower rates than FHA.
Your last option is to obtain a USDA mortgage if you are going to live in a rural area. While you still pay for mortgage insurance, it is much cheaper than FHA mortgage insurance. There are income limits on this program, and you must purchase a home in a designated rural area.
The bottom line on FHA mortgage insurance is that it something that helps millions of people buy a home years sooner, but most people want to get rid of it or never have it in the first place. It is an extra expense on top of your mortgage, taxes, and insurance. If you follow the tips above, you may be able to avoid FHA mortgage insurance or stop paying it sooner than later.
It is possible that the FHA commissioner will change the rules on FHA mortgage insurance in the future. If that happens, you could have other opportunities to not pay mortgage insurance.