What is mortgage insurance and why is it a requirement for FHA loans?

 

Mortgage insurance is a policy that protects lenders against losses that result from defaults on home mortgages. FHA requires both upfront and annual mortgage insurance for all borrowers, regardless of the amount of down payment. The up front mortgage insurance premium (UFMIP) also needs to be paid at the time of closing. This is normally 1.75% of the loan amount.

As the borrower, it will be your responsibility to pay the mortgage insurance premium (MIP), even if you have stellar credit and have never missed a monthly payment. It is simply a requirement for FHA loan borrowers who make a down payment of less than 20 percent on your home loans.

Conventional mortgages that have a down payment of under 20 percent also require mortgage insurance, called PMI, but there are ways to avoid paying those costs. However, since FHA loans have a minimum down payment rate set as low as 3.5 percent, it is compulsory that borrowers pay the MIP.

There are instances in which the MIP can be dropped. This depends on the amount you put down on the house, when the loan was originated, and your loan-to-value ratio. The FHA mortgage insurance agreement is between FHA and the mortgage company, so you must contact your mortgage company and ask them what they require to drop the insurance. Most mortgage companies will want you to have a substantial amount of equity in your home.