FHA loans are common among first-time buyers because they require just 3.5% down and allow more leniency for individuals with lower credit scores and higher debt-to-income ratios, but FHA borrowers pay a 1.25% annual mortgage insurance premium (typically hundreds of dollars each month on top of their mortgage payment and taxes).
This insurance premium lasts until the loan-to-value ratio–the amount owed divided by the purchase price–is 78%, or after five years, whichever comes later.
With the recent FHA changes, the mortgage insurance premium will increase slightly, and it will never go away.
The FHA will be making the following changes with regard to the mortgage insurance premium:
- The mortgage insurance premium (MIP) will last the entire life of the loan for loans with case numbers assigned on or after June 3rd.
- The mortgage insurance factor will increase from 1.25% to 1.35%, for loans with case numbers assigned on or after April 1st. This is based on a 3.5% down payment, varies for different loan-to-value ratios and loan amounts.
When do I get a case number? Good question. You’re given a case number once your signed offer is submitted to your lender.
What it means in dollars and cents
Under the current FHA guidelines, someone who buys a $400,000 home with a 30-year fixed-rate FHA loan will pay around $25,000 in mortgage insurance during the first five years.
Under the new system, the same borrower will pay around $160,000 over the course of 30 years unless he sells the home or refinances into a conventional loan. The only way to get out of the mortgage insurance premium after June 2nd is to refinance, and rates are not likely to stay at the historic lows we’re seeing today.
To put the mortgage insurance factor into perspective, assuming you got an interest rate of 3.25%, when you throw in mortgage insurance, it’s the same as if your mortgage interest rate was 4.6%. Historically, this isn’t too bad.
Should I still consider an FHA loan?
FHA loans still have their virtues. Just remember that you’ll have to refinance into a conventional loan if you want to shed the mortgage insurance premium after you’ve built up some equity in your home.
The most important thing you can do is meet with a lender you trust early in the process, well before you have to make a decision about which loan to get. A lender can help you weigh the advantages/disadvantages of each option and can help you plan early.
We’d like to thank Brian Thielicke (Cobalt Mortgage), who tipped us off to the change, and Matt Johnson (Sterling Bank), both of whom helped us write this post. Both are Redfin-recommended lenders and you can read all of their client reviews on Redfin Open Book, where we publish reviews of lenders from our own past clients.
You can read all the details about upcoming FHA changes in this letter from the Dept. of Housing and Urban Development.