What are FHA loans?
FHA loans are those backed by the U.S. Federal Housing Administration. This loan program is designed to assist lower-income or lower credit score borrowers with qualifying for homeownership — including first-time homebuyers.
That’s because FHA loan requirements are more relaxed than traditional conventional loan programs. For example, if your credit score is as low as 500-579, you can obtain an FHA loan with a down payment of just 10%. If your credit score is 580 or above, you will only need to make a 3.5% down payment.
Mortgage insurance requirements for an FHA loan
Borrowers using the FHA loan program must pay a mortgage insurance premium, no matter how much the down payment is. These payments are designed to reduce the risk for lenders who offer this loan program. Let’s take a closer look at the Mortgage Insurance requirements for FHA loans.
FHA loans require two distinct and different mortgage insurance premiums:
- An upfront MIP (UFMIP) (usually 1.75% of the total loan amount) is a one-time fee collected at loan closing. This coverage can be paid in cash at loan closing or most typically, added to the loan amount to reduce the amount of cash required to close.
- An annual MIP (historically 0.50% to 1.05%) is calculated by dividing the annual mortgage insurance premium by 12 and is collected with the borrowers’ monthly mortgage payments.
Conventional loans require a similar payment called Private Mortgage Insurance (PMI) for borrowers whose down payments are under 20%. The difference is that these PMI payments eventually disappear once the borrower reaches certain thresholds (i.e. equity position, mortgage payment history, and seasoning of the loan).
However, FHA loans require that if you make less than a 10% down payment, you will continue to pay these mortgage insurance premiums over the life span of the loan. When you make a down payment of greater than 10%, you’ll make the monthly annual MIP payments for 11 years.
While lower-income and/or lower credit score buyers can utilize an FHA loan to enter the housing market, their monthly payments and total amount to be repaid may be comparatively higher than a conventional loan.
Lower mortgage insurance premiums
On February 22, 2023, the Department of Housing and Urban Development (HUD) reduced annual mortgage insurance premiums by 30 basis points. For most homebuyers, this will reduce FHA mortgage insurance rates from 0.85 to 0.55 basis points. Let’s look at an example of the savings: On a $200,000 loan amount 30 basis points equates to $600. The $600 divided by 12 months would equate to a $50 a month savings on your monthly mortgage payment.
This new lower Annual MIP closes the gap between the cost of a traditional conventional mortgage loan and utilizing the FHA program.
The benefits of lower mortgage rates
This new decision provides a ray of hope to many first-time homebuyers.
According to a 2022 survey on CNBC, roughly three-quarters of Americans (74%) view homeownership as the pinnacle of the American dream. Yet the same survey reveals that young adults are reluctant to buy a home due to affordability concerns, with 69% willing to take drastic measures (such as moving to a different state) to improve their chances of buying a home.
These concerns are not without merit. According to data from Zillow, single-family homes sold for an average price of $348,000 in 2022. And while home prices aren’t expected to increase sharply, there’s no hint that they will drop anytime soon.
According to USA Today, roughly four out of five FHA borrowers are first-time buyers. These loan programs benefit many people of color, the recent reduction will also support greater social equity among underserved populations.
Lower monthly payments can provide some much-needed breathing room, especially while consumers continue to struggle with record inflation.
Details of the MIP reduction
What can borrowers expect from the recent decision by HUD? Here are some additional details surrounding the rate reduction.
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The MIP reduction goes into effect on March 20, 2023. It applies to all new FHA mortgage applications from that date forward.
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Unfortunately, current FHA borrowers will not receive a reduction in their current rates. It may be possible to refinance your FHA loan, though you’ll have to make sure that the money you save by refinancing will be more than your closing costs.
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While the MIP reduction will lower your payments, borrowers will still pay these fees according to the current schedule. Those with down payments of under 10% will continue to make payments for the life span of their loan, while other borrowers will pay over 11 years.
Alternatives to FHA loans
First-time buyers have several loan options that don’t require a down payment. For example, USDA loans don’t require down payments for homes in qualifying rural or suburban areas. Additionally, VA loans without down payments are available to current or former members of the U.S. Military (and their spouses).
Your state or city may have additional grants or programs to assist first-time or low-income buyers. If you need help deciding which options are right for you, check with a local loan officer.
