Understanding Mortgage Insurance on FHA Loans

Views: 374

An FHA loan 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 that Finance with a FHA Loan Forget to Factor Mortgage Insurance into Their Monthly Housing Expenses and That Is a Big Mistake!

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 2018. 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.

Many borrowers do not like to pay MIP or PMI, but it really does serve a good purpose that helps many Americans. Millions of us cannot afford to put 20% down on a home, which is the mortgage industry standard to get a loan without mortgage insurance. Without mortgage insurance, many people would have to rent their home for many years before they could afford to buy. Mortgage insurance, while an added monthly expense, allows people to buy a home with only 3.5% down in many situations. When people buy a home, they build equity in the home and are no longer tossing their money away on rent. Who wants to pay someone else’s mortgage by renting a home or apartment, anyway? Mortgage insurance brings home-ownership within reach to more Americans.

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 Loan Requirements to Consider Before Making an Offer on a Home

Although FHA loans 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

All loans offered through the Federal Housing Administration as of 2018 are required to have mortgage insurance, or MIP. People often refer to the mortgage insurance on a FHA loan, as PMI, but it is technically called mortgage insurance premium or MIP. FHA requires you to have mortgage insurance no matter what your down payment was. This program differs from conventional mortgages, as you do not need to pay for mortgage insurance when you make a 20% or more down payment.

Mortgage insurance is really not a bad thing; it guarantees the lender against default. MIP allows many Americans to become home owners sooner and stop paying rent. That said, most people hate mortgage insurance costs and want to get rid of it anyway possible.

Below is more information about FHA mortgage insurance and how you can cancel it.

Two Types of FHA Mortgage Insurance

First, there is upfront FHA mortgage insurance that is collected when you close the loan. The upfront premium is 1.75% of the amount of the loan. It is usually rolled into the loan but you can also pay it up front. If you refinance the FHA loan within three years of closing, you get a refund for the upfront MIP you did not use.

The other type of FHA mortgage insurance is the annual premium. This is divided into 12 monthly parts and is included with your monthly payment. If you are considering an FHA loan you should know that as of July 2013, you cannot cancel mortgage insurance after your loan to value reaches 78% or less. You need to carry MIP for the life of your loan. You must pay a yearly annual mortgage insurance premium that is between .80 and .85 basis points, depending upon the LTV of your loan.

How to Get Rid of Mortgage Insurance

If you got your FHA loan prior to July 3, 2013, and you have a loan to value of 78% or less, you should contact your lender to have the premium removed. This generally must be requested in writing. But if you got your FHA loan after July 3, 2013, and you put down under 10%, you must pay MIP for the life of the loan. You can remove mortgage insurance if you put down 10% or more. FHA changed its rules a few years ago and no longer lets you cancel MIP after you have 78% LTV.

If you have 20% or more equity in your property and are still paying for FHA mortgage insurance, your best option is to refinance into a conventional loan as soon as you can. This may require you to increase your credit score, lower debt and lower your debt to income ratio.

Most conventional loans today require at least a 620-credit score, but you will have a better chance with a higher score than that. You also should have a steady payment history in the last 12 months for all of the debts that show on your credit report.

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.

About Bryan Dornan

Bryan Dornan is a Financial Journalist and currently serves as Chief Editor of RefiGuide.org. Bryan has worked in the mortgage industry for over 20 years and has a wealth of experience in providing mortgage clients with the highest level of service in the industry. Bryan's continual focus is to promote affordable home-ownership to consumers like you across the United States. He also writes for RealtyTimes, Patch, Medium and other national publications. Find him on Twitter and Muckrack.