FHA mortgages have always been a great way for first-time homebuyers and borrowers with less than perfect credit to secure home financing. It offers low rates, good terms, and flexible guidelines. The FHA program has been a way for many more people to become homeowners than ever before. Something that anyone looking into FHA financing should know, however, is that there are two types of FHA insurance premiums that you will pay regardless of how much you put down on the home. Unlike conventional financing where if you put 20 percent of the price of the home down, you do not pay mortgage insurance premiums, everyone pays the premiums with FHA loans.
Upfront FHA Mortgage Insurance
The first type of mortgage insurance is upfront mortgage insurance. This is the fee you pay at the closing in order to have an FHA loan. Right now you pay 1.75 percent of the amount of the money you borrow. So for example, if you borrow $200,000, you would owe $3,500 for your upfront mortgage insurance. This is a one-time fee and you can choose to have it rolled into your loan amount without it affecting the loan-to-value ratio. In the above example, your total loan amount would equal $203,500, but your LTV would be based on the original $200,000 which is the difference between the purchase price and your down payment of at least 3.5 percent. The money paid towards this insurance premium is placed into an insurance fund and you do not pay it during any other time that you hold the loan. If you decide to refinance your FHA loan into another FHA loan in the next 3 years, you will receive a prorated portion of that insurance back towards your new loan’s upfront mortgage insurance.
Annual Mortgage Insurance
The annual mortgage insurance you pay is divided into 12 monthly payments even though it is calculated on a yearly basis. You pay the same amount in each of the 12 payments you make throughout the year. Right now, the rate borrowers pay for annual mortgage insurance 0.85% of the loan amount. This percentage has changed quite a few times since the original mortgage crisis in 2008, however. As of January 2015, 0.85% was the lowest rate the industry has seen since 2010. In the example of the $200,000 loan, you would be required to pay $141.67 per month for the life of the loan. The money collected from these insurance premiums is placed in an account that gets used if the FHA is called upon to repay a bank that had a home foreclosed upon.
Why Insurance Premiums are Necessary
The FHA requires insurance premiums in order to be able to back up the banks that provide the FHA loans. The FHA does not provide any loans or any funding – they simply set the guidelines that banks must abide by in order for them to guarantee the loan. This does not mean that the banks cannot add their own requirements to the loan program to make the process less risky, but at a minimum, every borrower must meet the requirements put forth by the FHA. Because of this guarantee, the FHA needs to collect the insurance premiums to have reserved funds to cover the homes that end up in foreclosure.
Because the foreclosure rates have decreased and the FHA’s reserved funds have reached an optimal point, the FHA was able to lower their annual rates to make them more affordable for borrowers. If there were to be another influx of foreclosures, the rates might have to increase again, but that is not happening in the foreseeable future. As of right now, borrowers can enjoy the low annual rate. The insurance cannot be canceled, however, if it was obtained any time after June 2013. The only way out of the insurance premiums is to refinance into a conventional loan, which is what many people tend to do after being able to gain some equity in the home and getting their credit scores where they need to be in order to qualify for conventional financing. FHA loans serve as a great starting point for many borrowers who are then able to move onto funding that does not require insurance payments for the life of the loan.