When deciding between an FHA mortgage and a conventional mortgage, the most important differenceÂ is arguably the mortgage insurance that the Federal Housing Administration requires. This insurance typically canâ€™t be canceled and comes with bothÂ an annual premium and anÂ upfront premium that youâ€™ll need to factor into your homebuying budget.
Despite these insurance-related drawbacks, an FHA loan may be the only option for borrowers who canâ€™tÂ qualify for a conventional loan due to a low credit score or a lack of savings â€” especially since down payments as low as 3.5% are permitted.
If youâ€™re considering an FHA loan, hereâ€™s what you should know about FHA mortgage insurance.
What is FHA mortgage insurance?
â€œMortgage insurance is essentially a policy that protects lenders and servicers against losses resulting from defaults,â€� says Jim Hettinger, executive vice president of operations at Guaranteed Rate, an online mortgage lender. Most mortgage loans require mortgage insurance only if the borrower is putting down less than 20% of the purchase price, he says, but the FHA requires it for all loans.
If an FHA loan is ideal for your financial situation, the mortgage insurance premium is something youâ€™re likely just going to have to live with, says Keith Gumbinger, vice president of HSH.com, a mortgage information website. â€œIf you want a low-down-payment mortgage that doesnâ€™t penalize you for having a lower credit score, the mortgage insurance premium is a fact of life,â€� he says.
How muchÂ does it cost?
When you take out an FHA mortgage, you must pay an upfront premium of 1.75% of the loan amount, according to the FHA. You can pay that premium at closing, or you can roll it into your loan amount. The latter will result in a more expensive loan.
In addition to this upfront premium, youâ€™ll also pay an annual premium that is added to your monthly mortgage payments. Depending on your loanâ€™s size and term, this expense ranges from 0.45% to 1.05% of the loan amount.
Take, for example, a $200,000 home. Say you put down $7,000, which is 3.5%, the lowest permitted for an FHA loan. The 1.75% upfront premium on your $193,000 loan would cost $3,377.50. If your annual premium was the highest amount, 1.05%, youâ€™d pay $2,026.50 per year, or roughly $169 per month.
How to cancel FHA mortgage insurance
If you put 10% or more down on your FHA loan, your mortgage insurance premiumÂ will end after 11 years. If your FHA loan was made beforeÂ June 2013, you may be able to cancel your mortgage insurance depending on your loanâ€™s original term or loan-to-value ratio. Contact your lender to see if you qualify.
If you donâ€™t fall into either of these categories, thereâ€™s something else you can do: refinance into a conventional loan once your LTV ratio is lower or youâ€™ve bolstered your credit score, Hettinger says. The loan-to-value ratio represents the amount of the loan compared withÂ the value of the asset. For example, if you put 20% down on a home that costs $100,000, your LTV is 80%.
If refinancing isnâ€™t an option, thereâ€™s still reason to keep hope alive, Gumbinger says. â€œThe FHA commissioner has wide discretion to change premiums and has a number of times in the past 10 years,â€� he explains. He says that borrowers might be able to cancel FHA mortgage insurance in the future or that annual premiums might be reduced. A quarter-percentage-point reduction of the premium was scheduled to take place in late January 2017, but it was suspended by the incoming Trump administration before it took effect.
Paying FHA mortgage insurance can be a pain, especially if youâ€™re stuck with it for the life of the loan. But this ongoing expense could be worthwhile for those who want to own a home and canâ€™t qualify for a conventional mortgage.
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