My readers are often confused by the insurance types that different loans require and one type of insurance that often comes up is the PMI or private mortgage insurance, which is an insurance type that is required for conventional mortgage loans.
Borrowers often believe that one of the major advantages of Federal Housing Administration-insured mortgage loans is that they don’t require private mortgage insurance.
While this is true, it’s important for all borrowers to be informed that FHA loans are not without their mortgage insurance requirements either.
In this article, I will clear up:
- The difference between PMIs and MIPs.
- Whether or not FHA loans require mortgage insurance.
- The mortgage insurance types borrowers must pay with an FHA loan.
- For how long are these FHA insurance premiums payable?
- How is the FHA mortgage insurance premium calculated?
Private Mortgage Insurance vs Mortgage Insurance Premium
Private mortgage insurance or PMI is required by conventional mortgage loans when the loan makes up more than 80% of the purchase price.
This is usually the case if the borrower makes a down-payment that’s less than 20% of the purchase price. With a down-payment of 20% or above, PMI is not required, which is actually a significant advantage of conventional loans compared to FHA loans.
Mortgage insurance premiums or MIPs, on the other hand, are related to FHA-insured mortgages, which are designed to protect the lender and they’re not a type of private insurance.
Which brings us to a common concern of borrowers about FHA loans:
Do FHA Loans Require PMI?
No, FHA loans do not require PMI, but they do require borrowers to pay a different kind of insurance — a government-provided insurance premium.
Private mortgage insurance is tied to conventional loan that don’t have any government backing, while FHA loans are insured by the federal government through the Federal Housing Administration.
Therefore, even though PMI is not required with FHA loan, mortgage insurance premiums are required, some even for the full life or full term of the mortgage obligation.
Mortgage Insurance Premium Required by FHA Loans
Now that we’ve cleared up the differences between PMI and MIP, let’s take a closer look at the mortgage insurance premiums required by FHA loans.
Loans that are backed by the federal government and so FHA loans require insurance designed to protect the lender from borrower default.
While FHA loans have general requirements that are easier to qualify for compared to conventional loans, plus FHA loans are more forgiving of a borrower’s bruised credit history, these advantages do come with the obligation to pay mortgage insurance premiums.
In fact, there are two types of MIPs that borrowers must pay with an FHA loan, which are mentioned on the HUD website:
“In most FHA programs, an Up-Front Mortgage Insurance Premium (UFMIP) is collected at loan closing; and an Annual Mortgage Insurance Premium (MIP) is collected in monthly installments.”
Therefore, a borrower in the FHA loan program will pay:
- An Up-Front Mortgage Insurance Premium (UFMIP), which is collected at the closing of the loan.
- An Annual Mortgage Insurance Premium (MIP), which is collected monthly.
Unfortunately, this is one of the major drawbacks of the FHA loan program, because MIPs can end up inflating your monthly premiums as opposed to conventional loans, which don’t even require insurance if you make a sizable down-payment.
Even so, the FHA loan program is an avenue that remains open for borrowers who want to buy a home but don’t qualify for a conventional mortgage loan.
For How Long are FHA Insurance Premiums Payable?
As I mentioned above, the UFMIP is payable in a lump sum up-front at the time of closing or it can be rolled into your loan, while the MIP is payable monthly.
For how long the MIP is payable depends on the down-payment put down by borrowers. Borrowers can end up paying this insurance for the life of the loan.
Before the new legislation that was adopted in 2013, the MIP could be canceled when the borrower reached a loan-to-value (LTV) ratio of 78%. This is no longer the case, unfortunately.
Since 2014, FHA borrowers must pay the MIP for the entire duration of the loan if their down-payment was less than 10%.
In other terms, whenever the LTV is greater than 90%, i.e. the borrower puts down less than 10%, the MIP is payable for the lifetime of the loan. This rule applies for all FHA purchase loans, regardless of term.
And since one of the appealing factors of FHA loans is precisely the low down-payment requirement (it can be as low as 3.5%), many borrowers will be bound by the MIP for the entire loan term.
But let’s take the scenario in which a borrower manages to make a down-payment of 10% or more? For how long do they have to pay the MIP?
In cases when borrowers can make a 10% or higher down-payment, the MIP is usually payable for 11 years.
Therefore, if you want to take advantage of the FHA loan program and you can make a 10% down-payment, you are no longer bound to pay the MIP for the entire loan term.
How is the FHA Mortgage Insurance Premium Calculated?
The up-front MIP is usually 1.75% of the loan amount. This is the premium you are asked to pay at closing, or you can choose to have it rolled into your loan.
Unlike most private mortgage insurance policies, the FHA uses amortized premium for the annual MIP, which means that costs change along with your loan amount.
To get an idea of how the MIP is calculated, you can use an FHA mortgage calculator, where you’ll be asked to submit your credit score, the value of the down-payment, the loan amount, etc.
Once all relevant information is submitted, the calculator will provide an itemized version of your monthly payment, monthly MI cost, and other values such as the loan cost or mortgage interest cost over a selected period, and other relevant information.
Based on your input, some calculators will also make a comparison between various loan types to help you choose the best loan version for you.
FHA Loan Features & Benefits
Now that you know that FHA loans don’t require PMI and the mortgage insurance premiums they do require instead, let’s have an overview of some of the other features and benefits of FHA loans.
FHA loans require a minimum 3.5% down-payment, which is lower than the down-payment required by conventional loans.
The 3.5% down-payment option, however, has a condition, which is that of a credit score of 580 or above.
Another benefit of the FHA loan program is that it’s available everywhere and to all buyers that would otherwise not qualify for a conventional loan.
Lower Credit Score Requirements
Now the HUD requires a minimum credit score of 580, however, lenders will have their own standards, and will usually want to see a credit score somewhere around 620.
Again, in theory, you could qualify for an FHA loan even with a lower credit score than 580, however, only if you can make a higher down-payment of at least 10%.
FHA Lending Amount Limits (County-Based & Updated Annually)
The loan amount limits of FHA loans depend on multiple factors such as the county in which it is requested, the type of property it is requested for, conventional loan limits, etc.
Lending amount limits are updated annually. In 2019, the ceiling was set at $726,525 for single-family home loans, which is the highest amount a borrower can receive for a single-family home.
The FHA floor was set at $314,827 for single-family homes, and this amount covers about 80% of all U.S. counties.
As I mentioned, lending limits are different based on the type of property that’s being purchased, therefore, the ceiling for a four-plex, for example, is set at $1,397,400.
If you’re worried about having to pay PMI for an FHA loan, don’t be as government-insured loans don’t require private sector insurance policies.
But don’t rejoice just yet, because FHA loans come with their own set of government insurance policies, namely the UFMIP and the annual MIP, which just like PMIs, they inflate your monthly mortgage payment.
The difference between UFMIP and MIP is that the first is payable once as a lump sum, while the MIP is payable each month for the entire loan term if your down-payment is below 10%.
Now that you have a better understanding of the different insurance premiums required by FHA loans, you can have a better overview of whether an FHA loan is right for you, or whether you’d be better off applying for a conventional or other loan instead.
To assess your options, you can use various online mortgage calculators and you can get in touch with your lender for more detailed information.
Ultimately, you must choose the type of loan that works best for you and the one you can qualify for based on your credit history, available savings and other financial factors.