FHA loans, insured by the Federal Housing Administration (FHA), are one of the most popular choices for people who want to buy a home or refinance an existing mortgage.
FHA loans require a very small down payment and have relatively relaxed guidelines for borrowers to qualify. But FHA loans aren’t the best choice for every borrower, in part because they require mortgage insurance, which adds an additional cost to the loan.
Use MoneyGeek’s FHA Mortgage Insurance Calculator to learn how much you will be paying to the FHA for the privilege of borrowing a loan under the FHA program.CALCULATE
What is Mortgage Insurance?
Mortgage insurance exists to protect lenders against losses they suffer when borrowers default. If a borrower defaults, the lender can foreclose on the loan and sell the home. The insurance covers all or part of the shortfall between the lender’s proceeds from the sale and the borrower’s unpaid loan amount.
Small down payment borrowers are perceived as being more likely to default since they have less equity at stake. That’s why lenders typically require mortgage insurance when a borrower makes a down payment that’s less than 20 percent of a home’s purchase price or appraised value.
Mortgage insurance is different from mortgage life insurance. Mortgage insurance, sometimes called mortgage default insurance, pays all or part of a lender’s loss when the borrower defaults. Mortgage life insurance pays off a loan when a borrower dies.
Although mortgage insurance protects the lender, the borrower pays for it. The benefit for the borrower is that mortgage insurance acts as an incentive for lenders to make loans to borrowers whose down payment is smaller than 20 percent — sometimes a lot smaller. The minimum down payment for a loan with FHA mortgage insurance is just 3.5 percent.
This example illustrates the benefit:
Minimum 20 percent down payment without mortgage insurance:$40,000 ($200,000 x 0.20 )
Minimum 3.5 percent down payment with FHA mortgage insurance:$7,000 ($200,000 x 0.035)
A borrower who has at least $7,000 for a down payment might be able to qualify for an FHA-insured mortgage to buy a $200,000 home. Without mortgage insurance, that same borrower would need a down payment of at least $40,000 to purchase that same home. That’s a difference of $33,000.
This lower upfront investment is especially helpful for first-time buyers who don’t have equity from the sale of their current home to use as a down payment for their next home.
How Much Does FHA Mortgage Insurance Cost?
FHA mortgage insurance involves two components: an upfront mortgage insurance premium (UFMIP) and an annual mortgage insurance premium (MIP).
The upfront premium is paid when the borrower gets the loan. The borrower doesn’t pay the fee immediately or in cash. Instead, the premium is added to the borrower’s loan amount. The current FHA upfront premium is 1.75 percent of the loan amount.
Here’s an example of how UFMIP is added to the loan:
The down payment percentage is based on the loan amount without the UFMIP, so a minimum 3.5 percent down payment would still be $7,000, not $7,122.50.
FHA’s Annual Mortgage Insurance Premium (MIP)
The annual premium is divided by 12, and that amount is added to the borrower’s monthly mortgage payment. This system means the borrower doesn’t have to pay the full amount all at once every year.
An individual borrower’s MIP can vary from less than $60 to several hundred dollars per month, depending on the borrower’s loan amount, loan term and down payment percentage. The borrower’s credit score doesn’t affect his or her MIP for FHA loans.
The monthly MIP calculation is complicated, so you should consult a mortgage professional for an FHA loan quote based on your situation.
FHA’s Current Mortgage Insurance Premium
|Loan Amount||Down payment or equity||MIP
(percentage of loan amount)
|Monthly charge on $100,000 loan|
|Less than $625,500||Less than 5 percent||0.85||$71|
|Less than $625,500||More than 5 percent||0.80||$67|
|More than $625,500||Less than 5 percent||1.05||$88|
|More than $625,500||More than 5 percent||1||$83|
FHA’s Mortgage Insurance Premium Through the Years
The FHA has changed its MIP multiple times in recent years. Each time the FHA raised its MIP, FHA loans became more expensive for borrowers. Each increase also meant some prospective borrowers weren’t able to qualify for or afford the higher monthly mortgage payments due to the MIP.
In January 2015, the FHA reversed course and cut its MIP to 0.85 percent for new 30-year, fixed-rate loans with less than 5 percent down. The FHA projected that this decrease would save new FHA borrowers $900 per year, or $75 per month, on average. The actual savings for individual borrowers depends on the type of property they own or purchase, their loan term, loan amount and down payment percentage.
Changes in FHA’s MIP apply only to new loans. Borrowers who’ve closed their loans don’t need to worry that their MIP will get more expensive later.
How to Lower Your
Mortgage Insurance Costs
Borrowers might wonder whether there are ways to lower their FHA mortgage insurance costs. Whether for good or ill, the fact is that FHA insurance is not negotiable or subject to discounts, coupons or the like.
In 2014, the FHA announced plans to introduce a program that would have offered borrowers a small MIP price break if they completed a homeownership class taught by an approved non-profit organization before they obtained their loan.
The FHA projected that the program, known as Homeowners Armed With Knowledge, or HAWK, would have saved homebuyers approximately $325 annually. Unfortunately for homebuyers, Congress did not fund the program for 2015, so the HAWK never flew.
There is one way borrowers can pay less for FHA insurance, although it’s not by way of a special deal. Since MIP is based in part on the borrower’s down payment percentage, making a 5 percent down payment instead of the minimum 3.5 percent could lower your MIP.
Depending on when you got your FHA loan, refinancing with FHA’s streamline refinance could help you reduce the mortgage insurance costs on your loan. You can also consider refinancing your FHA loan into a conventional mortgage.
How Does FHA Mortgage Insurance Compare to Other Options?
First-time buyers sometimes assume that the FHA loan is always the best choice. That’s true in some cases, but not all. Borrowers can find other home loans offering small down payments and in some cases cheaper mortgage insurance.
Conforming Loans with Private Mortgage Insurance (PMI)
Conforming loans get their name because they meet or conform to Fannie Mae or Freddie Mac guidelines for the loan amount and the borrower’s creditworthiness.
Conforming Loan Insurer
A loan conforming to Fannie Mae or Freddie Mac’s standards is not insured by either Fannie or Freddie. PMI is not government insured; it’s backed by private companies.
PMI Cost for Conforming Loans
PMI is generally cheaper than the mortgage insurance premiums on FHA loans. How much a borrower will pay for PMI depends on the loan type, down payment percentage, property type, location and other factors.
U.S. Department of Veterans Affairs Home Loans
A benefit of employment in the U.S. armed services (plus a limited number of other federal agencies) is eligibility for a VA loan. VA loans do not require a down payment or monthly mortgage insurance.
VA Loan Insurer
The VA pays most of the cost for insuring VA loans. The VA limits the amount it will insure based on the location of the home.
VA Loan Insurance Cost
Most VA borrowers pay an upfront funding fee. The fee ranges from 1.25 percent to 3.3 percent of the loan amount, depending on the borrower’s category of military service, down payment percentage and whether the loan is the borrower’s first VA loan. The fee can be paid in cash or financed.
U.S. Department of Agriculture Loans
The USDA offers several attractive loan programs. Most are limited to rural areas, and to people who have average or below-average income. If you live outside of an urban or suburban area, it pays to learn if you qualify for a USDA loan.
USDA Loan Insurer
Guaranteed by the U.S. Department of Agriculture, USDA loans do not require a down payment. USDA loans are designed to encourage rural development.
USDA Loan Insurance Cost
USDA loans have an upfront fee and annual fee. The upfront fee is 2 percent of the loan amount. The annual fee, paid monthly, is 0.4 percent of the loan amount. USDA fees are lower than FHA fees.
Alternatives to FHA’s MIP
When the FHA increased its MIP in the mid-2000s, the FHA loan became a less attractive option. The January 2015 MIP reduction could make FHA-insured loans more competitive, but that still doesn’t mean the FHA loan will be the best or cheapest choice for every borrower.
Some low-down payment loans, other than the FHA loan, allow borrowers to cancel their mortgage insurance after they’ve built up a certain amount of equity in their home. Homeowners can build equity through mortgage repayment, value appreciation or both.
In some cases, borrowers must request mortgage insurance cancellation. In other cases, the lender is required to cancel the insurance. The cancellation rules can be complicated, but borrowers have an opportunity to get rid of mortgage insurance at some point. With an FHA loan, it is more difficult for borrowers to stop paying for mortgage insurance.
This restriction can make an FHA loan more expensive than the other options, especially if the borrower keeps the loan for many years. If the borrower sells the home or refinances within a few years, the MIP cancellation requirements are not as material.
How to Stop Paying FHA
Borrowers who have an FHA loan may be able to stop paying for mortgage insurance once certain conditions are met.
As of June 2013, borrowers who have less than 10 percent equity must pay MIP for the life of their loan. Borrowers who have 10 percent equity or more must pay MIP for the full term of their loan or 11 years, whichever occurs first.
Borrowers whose loan was closed before June 2013 may be able to drop MIP sooner if:
- They pay MIP for at least five years.
- They have at least 22 percent equity based on their loan’s original amortization schedule.
- Their loan term is longer than 15 years.
Borrowers can also stop paying MIP if they sell their home, refinance into a new loan without FHA mortgage insurance or pay off their loan balance.
Are FHA Loans Worth It?
Many borrowers choose an FHA loan despite the potentially higher cost of FHA mortgage insurance. One reason is that the FHA’s minimum down payment of just 3.5 percent is one of the smallest allowed on any type of loan.
While some conforming, VA and USDA loans also allow borrowers to make a very small down payment, these loans can be more selective than the FHA loan in terms of who can qualify.
Fannie Mae insures one type of loan that has a minimum down payment of 3 percent with PMI. This loan is available only to buyers who haven’t owned a home during the previous three years and homeowners who want to refinance certain types of existing loans.
The VA loan allows borrowers to buy a home without a down payment. This loan is available only to U.S. military servicemembers, veterans and certain other borrowers. The FHA loan also offers low closing costs and easier credit qualifying guidelines, according to the FHA website.
Borrowers who have a moderately low credit score might be able to qualify for an FHA loan with a reasonable interest rate, while that same credit score might trigger a significantly higher interest rate for a non-FHA loan. Though the FHA mortgage insurance might be more expensive, the lower interest rate offsets some of that cost to the borrower.
Borrowers whose credit score is very low might be limited to the FHA loan for that reason alone. Most other types of loans have higher minimum required credit scores.
The bottom line is that home loans and mortgage insurance costs are complex and the comparison of an FHA loan to other loan options involves quite a few variables. The FHA loan might be the best choice for one borrower, but not another. The best way to figure out which loan makes sense for you is to talk with a mortgage professional about your personal situation and shop around so you can compare the costs of each loan.