FHA loans are attractive to some buyers because they come with lenient credit requirements, low closing costs and competitive interest rates.
The added expense of FHA mortgage insurance, however, is a key drawback to this avenue of financing. Upfront mortgage insurance premiums can be, and often are, financed into the loan amount, explains Peter Boomer, a mortgage executive with PNC Bank.
Naturally, that increases your monthly payment, as well. FHA borrowers are required to pay two mortgage insurance premiums: one upfront at closing, and another annually for as long as you repay the loan, in most cases. By comparison, conventional loans with less than 20 percent down come with private mortgage insurance PMI , charged every year until you have at least 20 percent equity in your home.
You might also encounter mortgage protection insurance MPI , which is not a requirement for an FHA loan or any other kind of mortgage. MPI is similar to disability or life insurance in that it pays your mortgage if you become disabled, lose your job or pass away. While the law has changed more than once on this issue, current guidance states that borrowers who put down less than 10 percent on an FHA loan must pay for FHA mortgage insurance until the entire loan term is over.
PMI on a conventional loan, on the other hand, can typically be cancelled once a homeowner has 20 percent equity in their home. All FHA loans involve mortgage insurance, either for the life of the loan or for a set number of years.
This could mean getting a conventional loan with a 20 percent down payment, but there are other options. With this type of loan, the lender covers the PMI in exchange for a higher interest rate.
Yet another option is a piggyback loan. With this type of loan, you make a 10 percent down payment, then get a second mortgage to add another 10 percent to your down payment.
There are also some special programs that allow borrowers to make a low down payment without PMI. These range from VA loans for eligible members of the military to programs directly from major banks and lenders.
From there, they take steps to improve their credit scores and acquire more equity in their homes so they can refinance out of their FHA loan into a conventional loan with better terms. Before paying off your loan, make sure to weigh the financial pros and cons.
The speed at which you can have mortgage insurance removed is obviously very different among FHA loans and conventional loans, but the costs are another key differentiator. The amount you pay for PMI can vary depending on your credit score and down payment amount. As described above, annual mortgage insurance premiums for FHA loans vary based on the loan term and loan amount. The mortgage insurance deduction lapsed in , but was brought back at the end of Because of this, you might be able to itemize FHA upfront MIP for tax year , and also retroactively for tax years , and Forking over an upfront premium is already a tough pill to swallow, and paying additional premiums for years or even decades can really eat into your budget.
Investing in a home now could be a smart move, and an FHA loan could be what you need to make it happen. You may be required to pay for mortgage insurance when you get a loan to purchase a house as well as when you refinance.
One important difference between the mortgage insurance requirements for FHA and conventional loans is the upfront mortgage insurance premium. Every person who buys a house with an FHA loan has to pay an upfront fee which is currently 1. Conventional loans do not have upfront mortgage insurance premiums. The cost of MIP depends on the term of your mortgage, the amount of your base loan amount, and your loan-to-value ratio LTV. While the cost of the annual premium can vary from borrower to borrower, the annual cost of MIP generally runs between 0.
The same is true when you refinance an FHA loan. You will need to pay upfront and annual mortgage insurance premiums when you refinance using an FHA loan. Unlike FHA loans, not every person who buys a house with a conventional loan is required to pay for mortgage insurance. The cost of PMI is affected by factors like your credit score and the amount of your down payment.
The cost can vary from borrower to borrower and generally runs between 0. There are similar requirements when you refinance a conventional loan. If you buy a house today with an FHA loan, you will be required to pay mortgage insurance premiums for at least 11 years. Homeowners with FHA loans sometimes refinance to a conventional loan to stop paying mortgage insurance premiums.
Then you can request your lender cancel your PMI payments. 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.
Borrowers who have an FHA loan may be able to stop paying for mortgage insurance once certain conditions are met. As of June , 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 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. 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. 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.
Marcie Geffner is an award-winning reporter, writer and editor. Geffner's current projects include stories and articles for real estate and mortgage websites and magazines.
She has been writing about home loans and property transactions for more than 20 years. By Marcie Geffner. What is Mortgage Insurance? This example illustrates the benefit:. Loan Amount. Down payment or equity.
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