If you have a tough time qualifying for a mortgage, you may want to look at the FHA program. The FHA has flexible guidelines that make it easier for borrowers with less than perfect credit or a high debt ratio to secure a loan.
Because the FHA offers such flexible guidelines, they require borrowers to pay for mortgage insurance. This mortgage insurance helps the lender should you default on the loan. It’s called a loan guarantee. If you stop making your payments, the FHA will pay the lender back a portion of the funds that they lost. This is what motivates lenders to give FHA loans in the first place.
Just how much mortgage insurance will you pay on an FHA loan? Keep reading to learn how to calculate it and to see what you should know about FHA mortgage insurance.
What are the Current FHA PMI Rates?
First, you should know that there are two different types of mortgage insurance on an FHA loan:
- Upfront Mortgage Insurance
- Annual Mortgage Insurance
The upfront mortgage insurance is a premium that you pay at the closing. The money goes straight to the FHA and is what helps them continue to guarantee loans. Right now, the FHA charges 1.75% of the loan amount at the closing. On a $200,000 loan, you’d pay $3,500 for the FHA loan.
The annual mortgage insurance is a premium you pay each year, but you make monthly payments. The lender calculates your mortgage insurance premium based on your current outstanding principal balance. They calculate the annual amount and then divide that amount up equally amongst your 12 monthly payments. Today, the annual premium is 0.85% of your loan amount.
Calculating FHA PMI
Understanding how to calculate the PMI on your FHA loan will help you know if you can afford the full payment. You’ll pay the monthly insurance premium in addition to your principal, interest, real estate taxes, and homeowner’s insurance.
Use the following formula to calculate your upfront premium. This is the premium that you pay as a part of your closing costs. We’ll use $200,000 as an example loan amount:
.0175 x $200,000 = $3,500
You can pay this amount out of your own funds, after proving that you have the funds or you can ask the seller to help you pay it.
Use the following formula to calculate your annual mortgage insurance premium:
.0085 x $200,000 = $1,700 (this is the annual premium)
$1,700/12 months = $141.67 monthly insurance premium
You’ll use the above example (.0085 x loan amount) each year as you pay your principal balance down. You can calculate the exact cost of your premiums for each year using the amortization table provided by the lender. This will tell you the maximum amount you’d pay each year. If you get ahead and are able to pay more of your principal balance down through the years, your premiums will decrease even further.
How Long Will you Pay FHA PMI?
Unfortunately, you pay FHA PMI for the entire term of the loan. Unlike conventional loans, you cannot request cancellation of the premium. You will pay the mortgage insurance premium the entire time that you hold an FHA loan.
The only ‘refund’ you will ever see on FHA mortgage insurance premiums is with the upfront mortgage insurance premium. The FHA offers a program called the FHA Streamline Refinance. If you use this program within the first three years of taking out an FHA loan, you will get a prorated refund of the upfront mortgage insurance that you paid.
You must wait until you have your current FHA loan for at least six months before you can refinance with the streamline program. After six months, if you qualify, you can refinance and receive 70% of your upfront mortgage insurance back. The amount of the refund that you receive will decrease each month until you hit the 36th month, at which point, you get only 10% of the amount that you paid back.
Now you don’t receive this money as cash in your pocket. Instead, the FHA uses the money to reduce the amount you must pay for the new FHA loan. Every time that you take out an FHA loan, you pay the upfront mortgage insurance.
Here’s an example:
If you refinance with the streamline program on a $200,000 loan, you’d owe $3,500 for the upfront mortgage insurance. But, if you refinanced just six months after taking out the original loan, the FHA would subtract 70% of that amount or $2,450. This would leave you owing just $1,050 at the closing.
You’ll still pay annual mortgage insurance even with the streamline refinance, but this time around, you’ll only pay 0.55% of the loan amount.
You’d use the following calculation to determine your annual mortgage insurance premium:
.0055 x loan amount/12 = Monthly Payment for Annual Mortgage Insurance Premium
Does FHA PMI Decrease Each Year?
Technically, FHA PMI doesn’t decrease each year. You pay the same fixed percentage each year. What does decrease is the amount that you owe, though.
As we discussed above, the lender determines the amount that you owe based on your current outstanding principal balance. If you make your payments on time each month, you pay the principal balance down on the loan. This decreases the cost of your insurance because you need to insure a lower loan amount. While the premiums never go away, they do decrease steadily, making it easier to afford as you get further into your loan term.
How to Eliminate FHA PMI
Unfortunately, today the only way to eliminate your FHA PMI is to refinance the loan. Many borrowers use the FHA loan to get the home they want. They then work to increase their credit score, stabilize their income, and decrease their debt ratio in order to qualify for a conventional loan.
If you do refinance into a conventional loan, you will pay PMI until you owe less than 80% of the home’s value. At that point, you can cancel the PMI. Some borrowers like to wait to refinance their FHA loan until they already owe less than 80% of the home’s value to save even more money.
FHA PMI is an extra cost, but it helps you get a loan that you otherwise probably wouldn’t qualify to receive. As with any loan, shop around with different lenders to find the best terms and interest rates. The mortgage insurance premiums won’t change no matter what you do, but the interest rate and terms will vary by lender.