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If you’re a first-time homebuyer, one of the mortgage programs available to you is the Federal Housing Administration loan or FHA.
For many potential homeowners, an FHA offers so many benefits compared to conventional loans.
From low down payment and credit score requirements, an FHA loan can be a great mortgage option when it comes to loan affordability.
However, just like other mortgage programs, FHA loans come with mortgage insurance, which makes FHA loans a bit expensive.
Keep reading to learn more about FHA mortgage insurance, its cost, what it covers, and how you can avoid it even as a first-time homebuyer.
What is FHA Mortgage Insurance?
An FHA mortgage insurance premium or FHA MIP refers to an additional fee you pay to a lender to protect the lenders if you default on your mortgage loan repayment.
It is common for borrowers to default on the repayment due to sudden financial hardship or even death.
When such unforeseen circumstances occur, a mortgage insurance premium protects the lender’s financial investment in the loan.
When you take out an FHA loan, you’re expected to pay two forms of mortgage insurance premium: one upfront usually paid at mortgage closing, and the second usually paid annually throughout the life of the loan, in most situations.
Most conventional loan lenders require borrowers to pay for premium mortgage insurance (PMI) when they make less than 20% down payment.
However, with an FHA loan, borrowers must pay for mortgage insurance premiums regardless of their down payment.
How Much Does FHA Mortgage Insurance Cost?
As we mentioned in the above section, you will face two types of mortgage insurance premium payments if you’re getting an FHA loan: upfront and extra annual payments.
Typically, your MIP upfront payment is usually equal to 1.75% of the total worth of your mortgage.
Take, for example, if you borrowed $200,000 to finance the purchase of your dream home, you’d pay up to $3,500 for your upfront payment. However, you should expect to pay around 0.45% to 1.05% of the total value of your loan amount on your annual MIP payment. Going by our example, you may spend between $900 to $2,100 annually.
Furthermore, upfront mortgage insurance payments are usually rolled into your loan amount.
So, if you borrowed $200,000 and rolled in the cost of your upfront MIP into your loan, your total loan amount will then become $203,500.
Your annual MIP payments, on the other hand, are usually added to your monthly mortgage payments.
The amount you pay for your annual MIP is highly influenced by your credit score, size of your down payment, loan amount, and length of the mortgage term.
>> More: Explore Government Home Loans
What Does FHA Mortgage Insurance Cover?
FHA mortgage insurance covers your lender if you default on the repayment or make late payments on the loan.
When this happens, the FHA protects the lenders’ financial interest by reimbursing the lender with a part of your principal received.
How Long Do You Have to Pay for FHA Insurance?
Before the year 2013, FHA MIP worked similarly to PMI, which is associated with conventional loans.
During the Pre-2013 period, borrowers were allowed to cancel their mortgage insurance premium once they achieved a certain level of equity in their home.
Today, FHA lenders no longer allow for such cancellation even when a borrower attains 60% of the equity in their homes.
FHA MIP is now bound to last for the entire life of the loan. However, there are exceptions to this new law.
One of such exceptions is that if you put forward at least 10% of the home price as a down payment, you will only have to pay for MIP for 11 years.
And if you put less than 10% at the time of closing, you are stuck with MIP payments for the life of the loan.
>> More: FHA vs. Conventional Loans
Can You Avoid FHA Mortgage Insurance?
The straight answer is No. You cannot outright avoid paying for mortgage insurance premiums.
However, you can take several proactive steps to reduce the amount you pay for MIP and the number of years you have to pay for it.
In the following section, we’ll highlight some of the steps to take to ‘avoid’ paying for mortgage insurance premiums, even as a first-time or seasoned homebuyer.
How to Avoid Paying for FHA Insurance
If you’re getting an FHA loan, then you’re bound to pay for mortgage insurance. This also applies when you put down less than the required 20% with conventional loans. However, you may be able to avoid mortgage insurance via the following methods:
Save up for a large downpayment
This is one of the easiest routes if you’re hoping to reduce the amount you pay for MIP and the number of years you pay for one.
If you can make a down payment of at least 10% during the closing, you will only have to make MIP payments for 11 years.
Refinance to a traditional mortgage
Another secret to ‘avoid’ paying for FHA insurance is switching to a conventional loan once you hit 20% equity in your home.
Usually, when you take out a conventional loan, you don’t pay for MIP but PMI – only if you put down less than 20%.
By refinancing to a conventional loan when you’ve reached 20% equity, you can easily avoid paying for MIP and also PMI when you make the switch.
If you’re planning to refinance to a conventional loan, you must meet the strict loan requirements associated with it. To qualify for a conventional loan, you’ll need to meet the following:
- A higher credit score: You’ll need to have a minimum FICO score of at least 620. So, it would help if you built your credit score before refinancing to a conventional loan.
- Debt-to-income ratio: Your DTI ratio must be 50% or less to refinance to a conventional loan. You can reduce your DTI ratio by paying down your debts and increasing your household income.
- Build home equity: If you want to avoid PMI when you refinance from your FHA loan to a traditional mortgage, then you must have reached 20% equity in your home before refinancing.
Aside from the above ways to avoid FHA mortgage insurance premiums, several government-backed or non-conforming loan types allow you to avoid mortgage insurance. These loans include:
Backed by the Federal Department of Veteran Affairs, VA loans do not require mortgage insurance.
So, if you’re a serving member of the US military, served in the military, or a military spouse, then you can take advantage of this zero down payments and mortgage insurance-free loan. However, VA loans require a funding fee between 1.4% – 3.6% of the loan amount.
>> More: Best VA Loan Lenders
USDA loans are designed to cater to individuals looking to purchase a house in a rural area.
USDA loans are backed by the United States Department of Agriculture and do not require borrowers to carry mortgage insurance no matter their down payment.
However, just like VA loans, USDA loans require an upfront fee of 1% of the loan amount and an annual fee of 0.35% that acts as its form of mortgage insurance.
FHA Insurance vs. Private Mortgage Insurance (PMI)
While Convention private mortgage insurance (PMI) and FHA mortgage insurance premium (MIP) are both mortgage insurance policies that protect a mortgage lender if a borrower defaults in the repayment of their mortgage, there are several differences between them.
|Private Mortgage Insurance (PMI)||FHA Mortgage Insurance Premium (MIP)|
|PMI is required when conventional loan borrowers make a downpayment of less than 20% of their potential home purchase price||While FHA requires a 3.5% downpayment, it requires an upfront MIP and an annual insurance premium regardless of the downpayment.|
|You may be able to cancel PMI once you achieve 20% equity in your home value.||With FHA MIP, you may be required to pay insurance premiums for the life of the loan. However, if you put over 10% down, you will have to pay MIP for 11 years.|
|Your credit score influences the private mortgage insurance rate that you receive. A lower FICO score will result in a higher PMI rate.||Your credit score doesn't influence the MIP rate you will receive from your lender.|
Bottom Line: FHA Mortgage Insurance Premium
FHA mortgage insurance premium is an additional cost you should budget for if you plan to take out an FHA loan regardless of the size of your downpayment.
Before opting for an FHA mortgage loan, check with your mortgage lender to find out the type of mortgage insurance, rates, and repayment term associated with your desired type of home loan.