Since 2002, first-time homebuyers have accounted for around 50% of the purchase mortgage market, according to the Consumer Financial Protection Bureau. In the last two decades, the first-time homebuyer market has expanded and contracted from 2.4 million in 2002 to 1 million in 2011 to 1.8 million in 2018.
Since 1934, the U.S. Department of Housing and Urban Development (HUD) has helped insure home loans through its Federal Housing Administration (FHA). Compared to conventional mortgages, FHA loans offer easier credit qualifications, lower down payments, and lower closing costs. But FHA loans require you to pay for FHA mortgage insurance, offered through lenders and FHA business partners.
- All FHA loans require FHA mortgage insurance.
- FHA mortgage insurance requires upfront and monthly payments.
- Upfront payments are based on the loan amount.
- Monthly payments are based on the mortgage’s loan-to-value ratio.
- The duration of FHA mortgage insurance premiums depends on a mortgage’s loan-to-value ratio.
What Is FHA Mortgage Insurance?
FHA mortgage insurance is government-backed insurance that protects the lender if the borrower defaults on a mortgage. The program extends mortgage insurance to FHA loans for one- to four-unit condominiums, houses, and manufactured homes. All FHA loans require mortgage insurance.
Homebuyers can apply FHA insured mortgages to new home purchases or refinances. The FHA mortgage insurance program offers protection for FHA and non-FHA home loans for up to 96.5% of a home’s value. This allows a qualified homebuyer to make a down payment as little as 3.5% while protecting the lender in case of foreclosure.
The FHA mortgage insurance program sets limits on maximum mortgage amounts, which can vary geographically.
How Much Does FHA Mortgage Insurance Cost?
Loans protected by FHA mortgage insurance require borrowers to make monthly premium payments and a payment at closing.
Upfront Mortgage Insurance Premium
At closing, borrowers must make an upfront mortgage insurance payment (UFMIP) based on basis points. One basis point equals 1/100 of 1% of the loan amount. For instance, if you borrow $300,000, 100 basis points would equal 1% or $3,000.
On loans backed by FHA mortgage insurance, borrowers must pay 175 basis points (1.75% of the loan amount) within 10 days of the closing or disbursement date. So, your $300,000 loan would require a $5,250 UFMIP.
Monthly Premium Payments
FHA mortgage insurance also requires borrowers to make monthly mortgage insurance premium (MIP) payments, which lenders must remit to HUD. FHA bases MIP rates on a mortgage’s loan-to-value (LTV) ratio, the percentage of a home’s appraised value that you financed. For example, if your home has a $200,000 appraised value and you finance $150,000, the mortgage has a 75% LTV.
The MIP rate also depends on the duration of the mortgage and loan amount. For instance, if you take out a 30-year mortgage less than or equal to $625,500, with an LTV of more than 95%, you pay MIP rates of 85 basis points. But if your mortgage has an LTV of 90% or less, you pay MIPs of 80 basis points.
Let’s say you buy a home for $300,000, make a 5% down payment, and mortgage it for 30 years, at an interest rate of 4.5%. You’ll pay monthly premium and interest payments of $1,469 and $189 in mortgage insurance.
MIP rates decrease over time based on amortization, the gradual reduction of the mortgage’s principal amount owed. As you pay off the debt, you also gain equity and reduce your mortgage’s LTV.
FHA Mortgage Insurance vs. Private Mortgage Insurance
|FHA Mortgage Insurance||Private Mortgage Insurance (PMI)|
|FHA loans, backed by the federal government||Conventional loans, offered through private insurers|
|Required for all FHA loans||Required for mortgages with less than a 20% down payment|
|Requires upfront and monthly payments||May require monthly payments, upfront, and monthly payments, or a lump-sum payment at closing|
|Duration based on a mortgage’s LTV||Duration based on the loan balance|
Who Provides Mortgage Insurance?
The federal government offers FHA mortgage insurance, while lenders offer PMI for conventional loans through private insurance companies. With both types of mortgage insurance, lenders collect premiums through monthly payments.
When Is it Required?
The FHA typically requires mortgage insurance for all its loans. Lenders may require PMI when a borrower can only make a small down payment, less than 20%, or has trouble qualifying for a conventional mortgage. To avoid paying PMI, borrowers may have the option to pay a higher interest rate.
FHA mortgage insurance requires making upfront and monthly payments. PMI may require monthly payments, upfront and monthly payments, or a lump-sum payment at closing.
Duration of Coverage
Homeowners who pay PMI can request cancellation of coverage after their loan amount reaches 80% of the home’s original value. Mortgage servicers must automatically suspend PMI after the balance reaches 78% of the home’s original value.
On the other hand, the duration of FHA mortgage insurance payments depends on the mortgage’s LTV. For example, if you take out a 30-year mortgage for $625,500 or less, and make at least a 10% down payment, you only pay FHA mortgage insurance for 11 years. But if you pay less than a 5% down payment, you must pay FHA mortgage insurance for the duration of the loan.
Other Considerations for First-Time Homebuyers
Before applying for a mortgage loan, you need to know how lenders determine eligibility. Commonly, lenders consider:
- Your household income
- How much of a down payment you can make (or, when refinancing, the amount of equity)
- Your credit score and credit history
- Your savings and other assets
- Your debt
- The value and condition of the home you want to purchase or refinance
Determine how much you can afford to pay each month. Consider changes such as an upcoming pay increase or a decrease in cash flow, like from a double income to a single income.
Lenders determine how much you can afford by calculating your debt-to-income ratio (DTI), your total monthly debt expenditures, divided by your total gross monthly income. For example, if you have monthly expenses of $3,000 and a gross household income of $10,000 per month, your DTI is 30%.
If you take out an adjustable-rate mortgage, determine how much more you can pay after it adjusts.
Check Your Credit Report
Typically, credit scores range from 300 to 850. Good credit scores fall between 670 and 739. Your credit score can determine whether a lender will make a loan and at what interest rate.
If you are turned down for a loan due to poor credit, take steps to improve your credit score before buying a house.
You are entitled to a free weekly credit report from the three credit reporting agencies: Equifax, Experian, and TransUnion.
If you’ve just started looking for a house, seek prequalification from lenders. The prequalification process doesn’t require you to submit supporting documentation, but helps you find out how much a lender will lend you, with no commitment.
Once you’ve determined how much you can afford to pay on a mortgage, get preapproved. The preapproval process requires submitting a full mortgage loan application and underwriting. Once approved, you can shop with confidence for your dream home.
Resources for First-time Homebuyers
Free federal and state government resources provide a wealth of information for homebuyers. Here are a few to get you started:
- Credit repair
- Federal programs to help pay for a home
- Free annual credit report
- Free HUD homebuyer counseling
- HUD’s “Home Economics” resources
- State-level homebuying programs
Frequently Asked Questions (FAQs)
How do you get rid of FHA mortgage insurance?
The duration of FHA mortgage insurance premiums depends on a mortgage’s LTV. If you make at least a 10% down payment, you can terminate premium payments after 11 years. But making a down payment of 5% or less requires making premium payments for the duration of the loan.
What does FHA mortgage insurance cover?
FHA mortgage insurance only protects the lender’s investment. If you default on an FHA loan, mortgage insurance will not protect you from foreclosure.
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Consumer Financial Protection Bureau. “Market Snapshot: First-time Homebuyers.”
FDIC.gov. “203(b) Mortgage Insurance Program”
Bank of America. “Glossary of Mortgage & Lending Terms”
Consumer Financial Protection Bureau. “What Is Private Mortgage Insurance?”
Consumer Financial Protection Bureau. “When Can I Remove my Private Mortgage Insurance From my Loan?”
HUD.gov. “Mortgage Insurance Premiums”
Equifax. “What Is a Good Credit Score?”
USA.gov. “Credit Reports and Scores”