If you’re contemplating buying your first home, you’ve probably done research about mortgages. One of the things you may have read about is FHA mortgage insurance. It’s required, but a lot of first-time homeowners don’t understand why they need it and how much it will cost.
We hear questions about FHA mortgage insurance frequently from our members, so we thought it would be helpful to explain the basics of how it works and why you need it.
What is FHA Mortgage Insurance?
Let’s start by talking about what FHA mortgage insurance is. Basically, it’s an insurance policy that protects lenders and servicers from default by homeowners.
We sometimes hear first-time homeowners say things like, “But I’m not going to default!” We understand that. It can sound as though the FHA is doubting your ability or willingness to repay your loan. However, it’s important not to take this requirement personally.
FHA mortgage insurance allows the FHA to loan to people who might not otherwise qualify for a mortgage. You don’t need to have perfect credit to get a loan. Later in this post, we’ll talk about what insurance is required for everybody who receives an FHA mortgage.
How Much is Mortgage Insurance?
FHA mortgage insurance requires payment of two separate premiums. The first one is equal to 1.75% of the loan amount. So, for example, if you took out a $150,000 FHA loan, your initial premium would be: $150,000 X 1.75%, or $2,625.
That might sound like a lot of money, but another thing you need to know is that you can finance the initial insurance premium at the same time you finance your mortgage. In other words, assistance is available to help you cover the initial premium.
The second premium is a monthly premium. It’s calculated as a percentage of your monthly payment. The percentage can vary depending upon the length of the mortgage, the amount of the mortgage and the initial loan-to-value ratio.
The main thing you need to know about the monthly payments is that they can range from a low of 0.45% to a high of 1.05%. If you can afford to make a substantial down payment and choose a short mortgage term, you’ll pay less than you would with a small down payment and a longer term.
For example, someone with a 30-year mortgage and a small down payment might end up paying close to the maximum of 1.05%. By contrast, someone who made a 15% down payment and chose a 20-year mortgage might fall at the lower end of the spectrum.
The monthly payments are calculated on an annual basis and then paid monthly. If you had a $200,000 mortgage and were paying 1% in premiums, your annual payment would be $2,000 and you’d pay $166.67 per month in premiums.
Why Do You Need FHA Mortgage Insurance?
Now let’s talk about why you need FHA mortgage insurance. The FHA, as we mentioned before, offers mortgages to people who might not otherwise be able to qualify for one. That means they routinely approve people with credit scores that other lenders would consider too low.
Often, people who qualify for FHA loans have little money for a down payment on a home. The minimum down payment for an FHA loan is 3.5%. The FHA ends up loaning most people a number that’s close to the full value of their home. That means FHA homeowners start with very little equity in their homes.
Because the FHA lends to people with less-than-perfect credit, there’s a higher risk of foreclosure and default than there would be with traditional banks and mortgage lenders. Of course, people with high credit scores and down payments can still default, but it’s less likely than with an FHA loan.
The FHA needs to protect itself against defaults so it can continue to offer mortgages and loans to the people who need them. Without insurance, they could be negatively impacted by foreclosures and be forced to change their loan policies accordingly.
In other words, the bottom line is that you need to buy FHA mortgage insurance so that the FHA can continue making affordable loans to you and people like you. FHA loans put homeownership in reach for people who might not otherwise be able to afford a home. When you get an FHA loan, you become part of a system that makes homeownership possible for people who might not qualify for a bank mortgage.
It can be daunting to think about paying insurance premiums on top of your monthly mortgage payments and other expenses associated with buying a home. But, FHA loans make the dream of homeownership a reality – and insurance is part of what makes that possible.
If you’d like to learn about our Addition Financial mortgage options, please click here.
Posted on Apr 14, 2018
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