Federal Housing Administration home loans are known for low interest rates and down payments. These are incentives for borrowers, and the FHA also provides an incentive for mortgage lenders in the program. This includes insurance coverage on the loans the lenders fund. FHA mortgage insurance is required on these loans when borrowers have less than a 20 percent down payment.
A key point of FHA mortgage programs is you can be approved for the loan with a smaller down payment. However, if you choose not to put at least 20 percent down, paying mortgage insurance premiums is required. The insurance policy provides protection for the lender if you default on your mortgage loan -- it offers no benefit to the borrower. If you default on your mortgage, the lender can foreclose on the home and try to sell it to recoup the loss. However, the lender may incur legal fees or the property might not sell for what is owed on it. The insurance provides extra financial support for the lender in these situations.
Because of the insurance, the lender takes on less risk when funding FHA mortgages than it does with conventional ones. This provides more leeway in the basic approval requirements such as credit score. In theory, you can only be approved for a loan you can afford. According to the requirements, the estimated mortgage payments shouldn't be more than 30 percent of your gross income.
Mortgage insurance premiums are calculated based on a percentage of the mortgage loan. Borrowers are charged an upfront premium, which is paid at closing. The rates for this are typically between 1 and 2 percent of the total mortgage. The fee can be paid with cash or financed into the loan. In addition to the upfront payment, borrowers pay monthly premiums. The monthly rates are usually no more than 0.5 percent. Multiplying the total loan amount by the rate gives you the yearly private mortgage insurance costs. Divided that by 12 to find the monthly contribution.
Once the loan balance reaches 78 percent of the home's original value, the insurance can be canceled. If you make extra payments and reach the threshold faster than expected, you will need to contact your lender to discuss cancellation. However, you loan needs to be at least five years old to do so.