FHA mortgages, backed by the Federal Housing Administration, are an excellent loan product for many Americans who have lower incomes and/or credit scores. But the FHA mortgage comes with one major downside: mortgage insurance.
FHA mortgage insurance or MIP is a special type of insurance policy that protects your lender if you default on your mortgage. This insurance allows the lender to issue credit to people with lower credit scores, higher debt to income ratios and lower incomes. FHA MIP reduces the risk for the lender, and you enjoy the benefits, which is namely having a mortgage with a low interest rate and down payment.
FHA MIP is paid for up front and each month. You need to pay an upfront premium of 1.75% of the loan amount, which is normally wrapped into the loan. In addition, you pay an annual premium that is part of your monthly mortgage payments. Depending upon the size and term of the loan, the expense is .45% to 1.05% of the amount of the loan.
The major downside with MIP is for most current loan holders with loans issued after June 2013, you must pay the insurance for the life of the loan. The only exception here is if you put down 10% or more on the loan. In this case, you can cancel the insurance after 11 years.
If you have an FHA loan and you want to get out of mortgage insurance, you really have only one major option, assuming you put down less than 10%: You need to refinance when you can out of the FHA loan into a conventional loan. When you have at least 20% equity in the home, that is when you should think about getting out of the FHA mortgage and going to a conventional loan.
Once you have 20% equity, you can usually get out of paying mortgage insurance on a conventional mortgage. You will need to show a solid payment history when you want to refinance, however. Many people are enjoying impressive gains in home values in 2018, with the average home value increase more than 6% across the US, and much higher in many markets. In San Antonio TX, for example, homes have increased 10% in value in the past year alone. This could provide a way for some people to refinance into a conventional loan with at least 20% equity.
But what if you got an FHA mortgage when rates were lower and now want to refinance when rates are higher? These days, rates are around 4.5% and even higher in some cases. In this situation, you may need to delay a refinance until rates have lowered.
If you think you cannot refinance right now, you may have another hope though. The commissioner for FHA has wide latitude to alter the premium structure on FHA loans and has done so several times in the past decade. It could be that the policy will change in the future so that you can cancel MIP sooner.
More About FHA Loans
Many Americans rely on FHA loans to buy their home because the terms for getting these loans are so good. FHA loans can be obtained with just a 580-fico score and a 3.5% down payment for many borrowers. This is one of the lowest down payment and most flexible mortgage programs in the country. Millions of Americans have been able to get a home loan much sooner by taking advantage of the FHA program.
Of course, the MIP requirement is a major annoyance for many borrowers. It seems hard to believe that you should have to pay $100 or $200 per month for mortgage insurance, especially for the entire life of the loan! But home owners should remember that getting an FHA loan probably allowed you to stop renting much sooner than if you had waited to qualify for a conventional loan.
The bottom line with FHA loans and MIP is that mortgage insurance is expensive, but it provides a way for people with lower credit scores and mediocre income to get a home loan much faster than they otherwise would. After you get an FHA loan and are approaching 20% equity, try to get your credit higher so you can refinance into a conventional loan. This is the best way to go for people who want to reduce their loan costs going forward.