As home buyers decide between an FHA and conventional mortgage, it is important to consider the matter of mortgage insurance. On a conventional mortgage, if you put down less than 20% down payment, you must have mortgage insurance until you have reached 20% equity. At that time, you can request that the insurance be cancelled.
Most FHA finance programs today are different. If your loan was written after June 2013, you usually have permanent mortgage insurance. Even if you have more than 20% equity in the property, you will have to pay for the insurance every month of the loan. The only exception is if you put down 10% or more; in such cases, you may cancel the insurance in year 11.
Is FHA worth paying mortgage insurance every month? That is the question.
Below is more information about FHA mortgage insurance that will help you decide if FHA is right for you.
FHA Mortgage Insurance Overview
Mortgage insurance is a policy that protects the lender and mortgage servicer from losses if you default on the loan. Most loans, as we noted earlier, require a 20% down payment to avoid mortgage insurance. But FHA now requires it for almost all loans.
Mortgage insurance for FHA loans is not cheap. You first must pay an upfront premium of 1.75% of the total loan amount. This premium can be paid at closing, or you can have it rolled into the loan amount. Note if you do the latter, the loan will be more expensive.
That is not all. You also must pay an annual mortgage insurance premium that is added to each loan payment. Depending upon the size and term of the loan, the expense will be from .45% to 1.05% of the amount of the loan.
For instance, if you have a $200,000 loan with $7,000 down or 3.5%, the upfront premium will cost you $3,370. If you pay 1.05% of the loan amount per year, that is $2,026 per year or about $169 per month.
Clearly, FHA mortgage insurance is expensive. So why get financing with a FHA program? FHA financing is much easier to qualify for; if you have a 580-credit score, you can still sometimes get an FHA insured loan with 3.5% down. For many Americans, an FHA program is the only option for them. In that case, it can be a perfectly acceptable financial decision. After all, if you wait until you qualify for a conventional loan with a higher credit score, you will need to pay rent for years longer. Many view renting as a waste of money. It is best, in this way of thinking, to buy as soon as you can, even if it comes with expensive mortgage insurance.
Cancelling FHA Mortgage Insurance
It was once easier to cancel FHA mortgage insurance. But in 2013, the reserve fund for the FHA program became too low, and new rules were passed so that most buyers must pay for mortgage insurance for the life of the loan. If you bought your home after June 2013, you will usually need to pay mortgage insurance for the life of the loan. For those with 10% or more down, you can cancel the insurance after 11 years.
So, is there any way to get rid of mortgage insurance if you put down less than 10%? It is possible that the rules can change again; the FHA commissioner has the authority to alter the regulations so that people can cancel mortgage insurance. If this does not happen, there is one other option: Refinance into a conventional loan once you have 20% or more equity. You will not need to pay mortgage insurance anymore with a conventional loan.
To do so, you need to improve your credit score. You can get FHA financing with a credit score in the high 500’s. But to get a loan approved with a conventional lender, expect to require a credit score of at least 620 and 640 will make it easier. Check the minimum credit scores needed for a FHA loan today.
The important thing to remember with FHA mortgage insurance is that it is an expensive fact of life if you have a lower credit score, and/or have a past financial problem on your credit report, such as a bankruptcy or foreclosure. While it is not an ideal option to pay for mortgage insurance for the life of the loan, it still can be a good decision to make financially. Anything beats paying rent for years and years.
Always reevaluate your situation and see if you can find a competitive mortgage with no PMI required. If you have an FHA insured lien, make it a goal to raise your credit score within a few years and refinance out of the loan into a conventional loan. You just need to determine when you will have 20% equity, so you can avoid mortgage insurance on the conventional loan.