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The FHA Loans and Requirements

This article discusses the qualification standards and costs involved in the Federal Housing Administration (FHA) loans for American homeowners. Afterwards, you would have picked up an understanding of the FHA's loan requirements, how they could benefit you, and how to make sense of their mortgage insurance premiums (MIPs).

What distinguishes the FHA from other lenders is the following:

  • Your down payment can be as low as 3.5% if you have a credit score of 580 and up.
  • Your credit score should be below 500, although exceptions can be made for people with "nontraditional credit history or insufficient credit" if they meet all other FHA requirements. 
  • According to FHA guidelines, your down payment has to be at least 10% if your credit score is between 500 and 579.
  • The FHA is able to provide loans in exchange for lower down payments because they get some of that money back from mortgage insurance premiums (MIPs).

Smaller Down Payments

Many first-time borrowers prefer FHA loans due to their less stringent qualification requirements. Where other lenders require a 20% down payment at the very least, the FHA stipulates as little as 3.5%. The FHA loan offers more for less but, as a lender, they still need a guarantee in the form of mortgage insurance premiums (MIPs) which are only applicable to borrowers with down payments of 20% or less.

Mortgage borrowers lean towards FHA loans because they offer fewer qualification requirements in exchange for very little down payment. Some of the money you save can go towards the MIP, which protects the lender if you default on the loan. The MIP is partly the reason why the FHA is able to provide mortgage loans at such low rates.

The Mortgage Insurance Premium

The mortgage insurance premiums (MIPs) are paid in two blocks: one in the form of monthly payments and the other paid along with the initial down payment. 

  • The MIP Paid in Advance: The initial mortgage insurance premium is currently worth 1.75% of an FHA loan.
  • The Annual MIP: The second block of the premium is made in the form of monthly payments, referred to as "annual MIP". The portion of the loan that the annual MIP accounts for depends on the loan-to-value ratio and the life and size of the loan.  

For information on how the LTV ratio relates to the annual MIP, click here.

 

For a Loan Term Greater than 15 Years
Amount of Loan Loan-To-Value Ratio Annual MIP
$625,500 or Less 95% or Less 80 bps
$625,500 or Less Greater than 95% 85 bps
Greater than $625,500 95% or Less 100 bps
Greater than $625,500 Greater than 95% 105 bps
For a Loan Term Less Than or Equal to 15 Years
Amount of Loan Loan-To-Value Ratio Annual MIP
Any Amount 78% or Less 45 bps
$625,500 or Less 90% or Less 45 bps
$625,500 or Less Greater than 90% 70 bps
Greater than $625,500 90% or Less 70 bps
Greater than $625,500 Greater than 90% 95 bps

 

How to Make Sense of the Annual MIP

The basis point (BPS) - used in the table - is the measuring unit of interest rates. One base-point is 1/100th (one-hundredth) of 1% of the loan amount. Let's use one example to derive both forms of the MIP.

An FHA loan that's worth $625,500 for a term of 15 years or less has an annual MIP of 45 bps. As mentioned earlier, the initial mortgage insurance premium is 1.75% of the loan amount. To find the upfront MIP, simply multiply the loan amount by 1.75% (0.0175), like so: 625,500 x 0.0175 = $10,937.5.

Now that you know your upfront MIP, the next step is to find the annual MIP. Subtracted from the loan amount, the upfront MIP leaves you with $614,562.5. We need to multiply this number by the FHA-disclosed basis points percentage which, in this case, is 45 bps. Since we know that one base-point is one-hundredth of 1% of your mortgage, we must first convert the BPS unit into a real quantity: 0.45 x 0.01 = 0.0045, divided by 12 - the number of months in a year - this gives us 0.000375. Afterwards, simply multiply the resulting number by your loan amount: 0.000375 x 625,500 = $234.6, and that is the monthly premium you'll be paying on top of your monthly installments.

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