When I was in the mortgage business, FHA mortgage insurance costs was always a delicate subject. Most, if not all new home buyers could not understand the need for it. I will try to explain to you why it is necessary.
Most first time home buyers do research into various aspects of home buying, that is why you are at this website right? Well I encourage you to think like the lender for a moment. Would you loan $100,000 to someone to buy a house who has a very little down payment, marginal credit and never had a mortgage before? You would want some kind of insurance right?
You want to be sure that the person you loan money to is going to repay you! I know some people would say that the home is the collateral. Well, yes it is, but all banks want lots of protection. Basically, they don't trust you and only look at it from the worst case scenario.
In fact, it is very common for people to ask their loan officers about FHA PMI (private mortgage insurance or MIP which stand for mortgage insurance premium) that they see on their good faith estimate. If you have been trying to get answers such questions in your head as well, then the following information and description should be of some use to you.
The most obvious question to ask would be what the FHA mortgage insurance is. The FHA mortgage insurance premium (MIP) that you pay is a financial guarantee for the lender that he would be compensated in case you are unable to pay the loan back or if you default. Remember the illustration above? You would not want to loan money without some assurance you are going to get repaid. So it is with the lenders.
There are two considerations here. Either the FHA mortgage insurance costs paid by you would be designed to completely eliminate losses for the lender or, at the very least, reduce them for him. In most cases, this insurance will make the lender whole if you should default for some reason.
The existence of mortgage insurance makes it feasible for lenders to provide loans to individuals who would otherwise be required to put up a larger down payment towards the home purchase. In most cases when you buy a home using the FHA home loan, your down payment is 3.5%. So with that in mind, the risk is really on the lender more than you. You do not have much cash in the deal.
In other words, you are able to purchase your home with such a low down payment because of the mortgage insurance that you have.
Therefore, the reason why you need to pay FHA PMI is simply that you would have to pay a much larger down payment for the home if you did not have it.
As a result of this, the fact that you pay this premium, means that the risks pertaining to potential default is being divided between the institution giving you the loan and the institution from which you have the insurance. When these risks are smaller for both, this makes the whole thing a viable transaction. It makes it much easier for everyone involved.
You are probably wondering when you can stop paying this FHA mortgage insurance premium. As of Jan 1st, 2013, this premium will never stop as long as you own the home. Before this date, your LTV had to be below 78% for these premiums to stop. So be prepared to pay fha mortgage insurance costs for as long as you live in the home. According to the 2011 Census, the average American moves 11.7 times in their life. So the chances of you keeping your mortgage for 30 years is rather slim anyway.
Remember, most conventional programs require a 10% down payment or more. The FHA program requires only a 3.5% down payment. So your down payment and closing costs will be a great deal lower with the FHA loan over the conventional loan. So do not let these FHA mortgage insurance costs (which are the premiums) scare you. They are there to make it possible for you, the first time home buyer, to qualify for a mortgage and buy that awesome house.
I hope all of this makes more sense to you now. There really is no way to get around this. It is just part of the home buying process. For additional information on this, feel free to use the link below to return to my FHA Home Loans main page.
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