If you take out an FHA loan, you will pay mortgage insurance no matter how much money you put down. The FHA requires at least a 3.5% down payment, but unlike conventional loans, even if you put 20% down, you will still pay mortgage insurance.
But how long must you pay the insurance?
When FHA Mortgage Insurance Ends
Unfortunately, FHA mortgage insurance never ends unless you pay the loan off in full. In other words, you pay mortgage insurance premium for the life of the loan. Granted, the amount you pay per month will decrease slightly as you pay your principal balance down.
The FHA charges 0.85% of your average loan balance for the year. As you pay your balance down, that amount will decrease slightly. But, again, you will pay premium for the life of the loan. Even when you have two or three years left and owe much less than 80% of the home’s value, you still pay the insurance.
Eliminating FHA Mortgage Insurance
If you don’t want to pay the mortgage insurance, you will have to refinance your loan. Many people use the FHA loan as their ‘starter loan.’ They don’t have a large down payment, so they take advantage of the FHA’s low down payment requirement of 3.5%. They then use the time they have the FHA loan to improve their credit and pay the balance of their loan down.
It typically makes the most sense to refinance your FHA loan into a conventional loan once you owe less than 80% of the home’s value. This can happen in one of two ways:
- You pay the principal balance down to the point that you owe less than 80% of the original value of the home.
- You pay for a new appraisal once you know your home appreciated enough that you owe less than 80% of the home’s new value.
If you buy a home in an area that appreciates, you may find that you owe less than 80% of the new value quicker than you would if you made the minimum required mortgage payments each month.
Getting Around the FHA Mortgage Insurance Requirement
The above standards apply to the average FHA homeowner that puts down less than 10% on the home. If you are among the elite few that put down more than 10% on a home bought with an FHA loan, you may be able to cancel your mortgage insurance.
Borrowers that put down 10% or more and take any FHA term between 15 – 30 years can have their mortgage insurance canceled after 11 years. While it doesn’t seem to make sense to use FHA financing if you have more than 10% to put down on the home, some borrowers still need the FHA’s flexibility, especially when it comes to credit scores. The FHA only requires a 580 credit score, whereas conventional loans typically require at least a 680 credit score.
FHA Versus Conventional Mortgage Insurance
If you have the credit scores and down payment to secure a conventional loan, you may want to see the difference between the two programs.
On a conventional loan, you pay PMI if you put less than 20% down on the home. The PMI rates may be slightly higher than what you’d pay for an FHA loan. But, you can cancel the PMI you pay on a conventional loan. As soon as you owe 80% or less of the home’s value, you can request cancellation.
Typically, you don’t have to refinance to get out of PMI. You can request that the lender cancel it as soon as you know you owe less than 80% of the home’s value. Be careful, though, some lenders will require that you pay the balance down to less than 80% of the home’s original value. While some lenders will allow you to pay for a new appraisal and base your LTV on the new value of the home (assuming it appreciated).
If your lender won’t cancel your PMI until you owe less than 80% of the home’s original value, you may have to refinance, much like you would to get out of paying FHA mortgage insurance.
The mortgage insurance helps protect lenders should you default on the loan. Lenders require this insurance on ‘risky’ loans. FHA loans are risky because of the low down payment along with the flexible underwriting guidelines. Most lenders wouldn’t give a loan to a borrower that had a 580 credit score, 97.5% LTV, and a 41% debt ratio, but FHA loans allow that. Lenders are often willing to provide the loans because the mortgage insurance guarantees that they will receive reimbursement of some sort should you default on the loan.