The Federal Housing Administration (FHA) supports mortgage lending to people with low-to-moderate incomes and/or lower credit scores who may not otherwise obtain a home loan. An FHA loan enables you to purchase a home with a lower down payment, but your FHA loan will come with high mortgage insurance costs. These increase your monthly payment.
Is Mortgage Insurance Expensive?
Any amount of money that you pay for nothing is high. Mortgage insurance covers losses that a lender incurs when a borrower defaults on a loan. As a result, the money that you pay for mortgage insurance will never benefit you. The money that it adds to your monthly payment does nothing to pay your interest or build equity.
High Mortgage Insurance Costs for FHA Loan
As a single-family home FHA borrower, you are responsible for paying two mortgage insurance bills. The first one is the Upfront Mortgage Insurance Premium (UMIP) that is due at closing. UMIP costs you 1.75% of the loan amount. That translates into $1,750 for every $100,000 that you borrow. On a $200,000 loan, you owe $3,500 at closing.
Depending on your lender’s policies, you may have the option of adding the UMIP expense to your loan amount. This spares you from having to cough up that cash along with other closing costs, but doing this adds to the total loan that you’ll be paying back with interest.
After paying the UMIP at closing, your FHA home loan requires annual payments for mortgage insurance. The money for the annual mortgage insurance premium (MIP) payment is collected with monthly installments included in your home loan payment. These add to your monthly cost for the life of the loan.
The cost of the ongoing MIP varies in relation to a number of factors, such as the term of the loan and the loan-to-value ratio. Expect the cost to fall somewhere between 0.45% to 1.05% of the mortgage balance.
Use a loan balance of $200,000 as an example with the lowest possible MIP rate of 0.45%. The annual MIP cost would be $200,000 x .0045 = $900. Now divide 900 by 12 months, or 900/12 = $75. This would add $75 to your monthly home loan payment. Keep in mind that this is an example on the low end of the MIP annual rate.
Rules about how much and when borrowers buy mortgage insurance for an FHA loan have shifted throughout the years. Currently, an FHA loan, whether for a purchase or refinance, will obligate you to pay the UMIP and annual payments. A large down payment or high equity cannot remove this requirement although it could impact the cost of your annual insurance payments.
In my work as a notary signing agent, I’ve been present when borrowers fully grasp the reality of high mortgage insurance costs. When it comes time to sign the loan paperwork at closing, people have questioned the charges for the mortgage insurance during refinances. They expected that no mortgage insurance would be needed due to having plenty of equity in their homes even after the refinance. However, as an FHA loan, the mortgage insurance was mandatory.
Are FHA Loans a Good Deal?
Despite the high mortgage insurance costs attached to FHA loans, they do serve the purpose of helping people buy homes when they may not otherwise be able to do so. The program exists to aid people with lower incomes or credit struggles to become homeowners.
This is widely viewed as a laudable goal because homeownership has a great potential to add stability to your life. A landlord can’t displace you in favor of a tenant willing to pay more. You won’t have to endure hefty rent increases that destroy your budget.
Yes, as a homeowner, you have to pay property taxes and insurance. These are big bills, but you pay these same bills as a renter. Those costs are always included in your rent.
If you wish to own a home, an FHA loan can be the vehicle that gets you to that destination. An FHA loan is a viable way to obtain property, and millions of people have done it. FHA lenders offer competitive interest rates for home buyers. They are not bad deals for borrowers as long as you understand that additional closing costs and MIP annual payments.
What’s most important when taking out an FHA home loan is that your total monthly payment with taxes, homeowners insurance, and mortgage insurance works with your budget.
When Is an FHA Loan the Right Thing to Do?
With an FHA loan, you can proceed with a purchase even if you don’t have a large down payment. Down payments for an FHA home purchase go as low as 3.5% of the house’s price although you will need up to 10% for a down payment if your credit history is wobbly.
The option to buy a house with a low down payment lets you buy now instead of later or never. Saving up tens of thousands of dollars could take some people many years to accomplish, if they ever make it.
Being able to buy with a low down payment gives you a chance to meet your goals or take advantage of a home for sale in a location that is desirable to you.
People with high debt-to-income ratios could find that an FHA loan is the right choice for them. Loans that lack federal backing are too risky for lenders to extend to people who will struggle to pay debts if their income falls. Federal government guarantees enable FHA lenders to take this risk and enable people to acquire property.
High mortgage insurance costs are certainly something to think about when making financial decisions about home ownership. If you can avoid mortgage insurance requirements, you should do so, but, if that is not realistic for you, then an FHA loan makes the purchase possible.
The FHA loan program is meant to assist low-to-moderate income people with home ownership. The mortgage insurance requirements increase their costs, but this is necessary to encourage lenders to issue these loans. Almost everything costs lower income people more, and this is true with a single-family home FHA loan.
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