Do you currently have an FHA-insured loan? If you've thought about refinancing recently given how low mortgage rates have been this year, it may be in your best interest to see if switching to a conventional loan could save you money by eliminating your monthly mortgage insurance payments. Read more to learn about the potential benefits of making the switch.
How do FHA loans work?
FHA loans are mortgages backed by the Federal Housing Administration, which is a part of the federal Department of Housing and Urban Development.
FHA loans are insured by the government and allow borrowers who may not be able to qualify for a conventional loan to buy a home.
FHA loan requirements differ for individual loan types, but they do require as little as a 3.5% down payment on a home purchase. FHA loans can be a solid option for people who are buying their first house, those with a lower credit score, or those with a challenging credit history.
What makes FHA loans different than some conventional loans is that FHA loans require mortgage insurance, in two forms. First, there is an upfront payment for mortgage insurance. There are also separate monthly mortgage insurance payments for as long as the life of the loan, depending on the loan-to-value ratio.
FHA mortgage insurance explained
As we discussed above, FHA loans require that borrowers pay MIP, or Mortgage Insurance Premiums.
The purpose of borrowers paying for FHA mortgage insurance is to protect the lender should a borrower go into default. FHA mortgage insurance premiums go into the “Mutual Mortgage Insurance Fund,” which is a government fund that pays the lender if a borrower defaults.
The mortgage insurance premium makes it possible for people who may not be able to qualify for a conventional loan to buy a home. In exchange, they are required to pay an insurance premium to counteract the risk to the lender.
FHA mortgage insurance is broken down into a one-time payment called the Up Front Mortgage Insurance Premium (UFMIP), and the monthly mortgage insurance payments (MI).
How much does FHA insurance cost?
For all FHA loans, the UPMIP payment is 175 basis points (or 1.75%) of the amount of the loan. Here’s how it works. Let’s take a $250,000 loan as an example. On a loan of that size, the UFMIP would be $4,375.
The UFMIP payment is due at closing. Alternatively, it can be rolled into the balance of your loan and you would pay back the fee over time with interest.
That’s the upfront payment. The monthly payments are separate. The monthly payment amount is sliding scale, wherein the more you put down up front, the lower your monthly MI premium is. How much you put down also dictates how long you will be paying for FHA insurance.
If you put down 10% or more on a 30-year FHA loan of $625,500 or less, your yearly premium will be 80 basis points (or 0.80%) of the total loan amount, paid out in monthly installments, for 11 years.
If your down payment is between 5% and 9.99% on a 30-year FHA loan of $625,500 or less, your yearly premium will be 80 basis points (or 0.80%) of the total loan amount, paid out in monthly installments, but the monthly premium lasts for the life of your loan.
Meanwhile, if your down payment is less than 5% (and remember, the minimum down payment for an FHA loan is 3.5%) on a 30-year FHA loan, of $625,500 or less, your yearly premium will be 85 basis points (or 0.85%) of the total loan amount, paid out in monthly installments. The monthly premium on these loans lasts for the life of your loan as well.
Think of it this way: if you are a first-time homebuyer who puts down 3.5% on a 30-year FHA loan for $250,000, your yearly MI premium is $2,125, paid out in 12 monthly installments of approximately $177 for the full 30-year term of the loan.
Eliminate MIP with a Conventional Loan
The good news is that you don’t necessarily have to pay that insurance premium every month. There are options for you. One is to refinance your FHA loan into a conventional loan without mortgage insurance.
Conventional loans often do not carry the same number of provisions that FHA loans do. Conventional loans do not require mortgage insurance if the borrower holds 20% equity (the difference between the amount of money you owe and what your home is worth).
So, if you currently have 20% equity in your home, you may be able to refinance your FHA loan into a conventional one and remove the mortgage insurance.
Should you make the switch?
Before you consider a conventional mortgage refinance, you should find how much equity you have in your home. You should review your current loan balance and compare it to the current value of your home, which may have risen or decreased since you first bought the property.
If you are at or above that 20% equity threshold, exploring your refinancing options may be a worthwhile exercise as you may be able to eliminate that monthly MI premium.
It should be noted that FHA loans and conventional loans do not have the same credit standards, so depending your situation, you may not be able to qualify for a conventional loan.
When deciding if refinancing is right for you, make sure to consider what home prices and mortgage rates may do in the future. You should also evaluate all costs and benefits, as refinancing into a new loan will carry some closing costs that will need to be paid, either up front or rolled into the loan.
After evaluating, you may find that your current FHA loan is already your best option or find that you would benefit from making the switch to a conventional refinance.
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