The FHA loan is a mortgage product offered by the Federal Department of Housing and Urban Development (HUD). This mortgage type has a number of advantages for low-income and below average credit borrowers: the down payment requirement is only 3.5 percent and the credit requirements are much lower than traditional mortgages. There are also some disadvantages, such as the way private mortgage insurance is added to this loan. FHA private mortgage insurance is called mortgage insurance premiums (MIP) and is paid either upfront or monthly. Mortgage insurance is used to help fund the FHA loan program and lessen the risk posed by risky borrowers.
Upfront
The first part of MIP is charged upfront in the closing costs of the mortgage. FHA loans use a variable rate of between 1.5 and 2.25 percent of the loan amount, depending on the credit score of the borrower. Conventional loans do not charge any upfront mortgage insurance costs, so the closing costs of a FHA loan may be significantly higher than a normal loan product. The borrower has the option of rolling the upfront MIP into the mortgage loan.
Monthly
The second component of MIP is added to your mortgage payment and charged monthly. This payment is .5 percent of the mortgage amount annually, spread throughout the year. This cost is identical between conventional and FHA mortgages.
Cancellation
There are a few situations in which you can stop paying MIP. Mortgage insurance is required only when the borrower does not have a high enough financial stake in the home. A higher down payment in 15-year mortgages allows a borrower to avoid MIP entirely, and once the loan amount comes down enough in other mortgage products, MIP is removed.
FHA mortgages are subject to MIP until the borrower has 22% equity in the home and has paid mortgage insurance for 5 years. MIP is avoided completely in 15 year mortgages with 89.99 percent loan to value.
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