FHA Makes Strict Guidelines
A series of FHA premium hikes in recent years has removed some of the luster from these popular mortgages. Since the latest increase in 2013, borrowers with a 30-year loan and 10% down now have to pay 1.3% in annual mortgage insurance premiums. And that’s on top of an upfront mortgage premium worth 1.75% of the loan amount.
The FHA also reversed course on its policy of cancelling annual premiums once the loan-to-value ratio is reduced to 78%. If you put at least 10% down at closing, you now have to worry about MIP for at least the first 11 years of your loan. And if you contributed less than that when you bought your home, the premium stays with you for the duration of the loan.
The following chart shows current annual mortgage insurance premiums (MIP) for FHA loans.
2 Mortgage Insurance Programs
First, it’s important to understand the two basic types of mortgage insurance (don't confuse it with mortgage life insurance). Both are triggered if you can't put down 20% of the home's cost when you take out the mortgage.
If you apply for a conventional loan, the bank will make you take out private mortgage insurance (PMI). As the name implies, your premium goes to a private company that reimburses the bank if you stop paying your mortgage. When your mortgage payments show that your equity in the house reaches 22%, you can have the policy canceled.
In the case of a Federal Housing Administration (FHA) loan, you pay mortgage insurance premiums (MIP) to a government entity, which protects approved lenders against borrowers who default.
When most lenders began toughening their underwriting standards in the wake of the financial crisis, borrowers started flocking to FHA loans. With its low down-payment requirements – as little as 3.5% – and willingness to accept relatively low credit scores, the agency provided a viable option for low- and moderate-income homeowners.
If you’re looking to a buy a home with less than 20% down, chances are you’ll have to pay for mortgage insurance on top of your regular interest and principal. It might seem that an FHA loan would be a better deal, but if you need mortgage insurance, that may not be the case.
Conventional Mortgage PMI
These new strictures make a conventional mortgage with PMI – if you can get one – a better bargain in many cases. The average private mortgage insurance payment is between 0.3% and 1.15% of the loan each year, with no upfront cost. In most cases you can request cancellation of PMI once you’ve attained 22% equity in the home.
Let’s look at two homeowners with a $250,000 mortgage over 30 years: One takes out an FHA loan with 5% down and the other gets a nearly identical, conventional loan. Assuming a PMI rate of 0.8%, the one with private insurance will save more than $1,000 each year in lower payments. Another big difference: The borrower with the conventional mortgage can cancel the premium once he or she acquires enough equity.
The one factor that still gives the FHA an advantage over most other home loans: ease of qualifying. If your credit score prohibits you from getting a loan elsewhere, a higher mortgage insurance fee might be something you can live with. Another option is to take out an FHA loan and, once you rebuild your credit, try to refinance with a conventional mortgage.
In light of recent insurance-premium hikes, it’s worth researching your options before taking out an FHA loan if you plan to put down less than 20% on your home. But if a government-backed loan is your only way of attaining home ownership, it may be a sacrifice worth making.
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