FHA loans have their advantages: less money down, more generous rules to qualify, and decent interest rates. The Federal Housing Administration was busy in 2013, however, adjusting the requirement for mortgage insurance – which the FHA calls a mortgage insurance premium or MIP – to help bolster its insurance fund. The fund pays out to mortgage lenders when borrowers default. As a result, you might not see the same savings on an FHA loan that you would have realized before 2013.
Mortgage insurance on an FHA loan begins with an up-front mortgage insurance payment -- or UPMIP for short -- at the time of closing:1.75 percent of the amount you’re borrowing. If you're taking out a $200,000 loan, this amounts to $3,500. On a $400,000 mortgage, it's $7,000. Your calculations begin with this number.
You must also pay annual premiums, and they last for the life of your loan. This is a change from the rules before 2013 when you were only required to pay MIP until you built up 22 percent in equity or for five years, whichever occurred later. Annual premiums are based on your average loan balance that year, so you'll have to figure out the amortization to calculate how much MIP you'll pay overall. As of 2013, the rate is 1.3 percent of your balance if you put down 5 percent or more. If you put down less than 5 percent, it jumps to 1.35 percent. With a $200,000 mortgage balance, assuming you put down more than 5 percent, you'd pay an additional $216 a month plus change, or $2,600 for the first year. For a more precise calculation based on amortization of your loan from month to month and your remaining principal, the Department of Housing and Urban Development offers instructions on its website. After you have your yearly numbers, add them to your UPMIP for your total mortgage insurance costs.
PMI rates increase if you take out a mortgage for $625,500 or more. These jumbo loans present more of a risk to the FHA, so premiums are higher – 1.45 percent if you put down 5 percent or more, and 1.5 percent if your down payment is less than this. On a $650,000 mortgage, your up-front premium would be $11,375, and your premiums during the first year would run about $785 a month if you put down more than 5 percent, an additional $9,425 a year until your payments begin whittling away at the principal balance.
Assuming you don't have credit problems and that coming up with a down payment of 10 percent or more is not an obstacle for you, you might be better off with a conventional loan, which requires private mortgage insurance, or PMI. You'll probably pay much less in PMI because it will last for a much shorter period of time – until you reach 22 percent equity in the home. PMI rates are often lower than comparable rates you pay with an FHA loan as well.
Beverly Bird has been writing professionally for over 30 years. She specializes in personal finance and w, bankruptcy, and she writes as the tax expert for The Balance.