FHA Mortgage Insurance: An Overview

On the strength of renewed federal support, the FHA is poised to pick up the pace of insuring mortgage loans. If you're in the market to buy or refinance, take a few minutes to learn how this important mortgage financing option works.

If the Federal Housing Administration (FHA) were to start running advertisements, the slogan might be: "We're the FHA. We don't make loans, we insure them." While there is a lot of discussion out there about FHA mortgages, many prospective borrowers still have questions about the agency's role in the process, and the insurance that makes these loans possible.

To set the record straight, the FHA establishes guidelines for various types of mortgages. These guidelines include more lenient qualification standards, and more attractive loan terms. Lenders agree to these parameters because borrowers are obligated to purchase FHA mortgage insurance. This provides the lender with added protection against losses resulting from a potential borrower default.

No free lunch

The premiums for FHA mortgage insurance are paid by the borrower. On 30-year loans, there's an upfront cost of 1.5 percent of the loan amount, plus a monthly premium of some 0.0417 percent of the loan amount. This monthly figure is derived from an annual insurance fee of 0.5 percent, which is divided by 12, and added to the loan repayments. Applying these percentages to a $300,000 mortgage, for example, results in premiums of $4,500 upfront, and $125 monthly.

On a 15-year mortgage, the upfront premium is 1.5 percent, and the monthly premium is about 0.0208 percent of the loan amount.

Not a life sentence

The borrower is not obligated to pay the monthly premiums indefinitely. If the term is longer than 15 years, they will end when the loan-to-value hits 78 percent-as long as the borrower has paid the premiums for at least five years. If the mortgage term is 15-years or less, and the initial loan-to-value was 90 percent or more, the premiums end when the loan-to-value reaches 78 percent, no matter how many premium payments the borrower has made. If the mortgage term is 15-years or less, and the initial loan-to-value is less than 90 percent, the borrower isn't charged the monthly premiums.

The FHA uses either the sales price or the appraised value at closing (whichever is lower) to determine when the loan-to-value drops to the 78 percent level. This means that property value increases occurring after loan closing are disregarded by the FHA for the purposes of determining when the monthly premiums end. For this reason, most borrowers can expect to pay the monthly premiums for about five years. In reality, many will refinance the mortgage before reaching the 78 percent threshold.

Further questions about FHA mortgage insurance should be directed to a reputable and experienced FHA lender, because you aren't likely to see FHA commercials running in primetime slots anytime soon.