The Federal Housing Administration has made homeownership possible for millions of borrowers who might otherwise be rejected for a mortgage loan. As an FHA borrower, you can purchase or refinance an owner-occupied, single-family home with a low 3.5 percent down payment. You also face less stringent credit and income requirements. The government insurance guarantee behind each FHA loan allows lenders to take the financial risk on you as a first-time home loan borrower. You must, however, pay the mortgage insurance premium for a certain amount of time.
Mortgage insurance is a feature of most home loans that have a down payment requirement of less than 20 percent. Lenders prefer to finance a borrower who invests a large amount of his own funds, as this reduces the chances of default. Mortgage insurance typically comes into play when the borrower owes more than 80 percent of the home's value. An FHA loan must meet certain requirements before the lender can remove the mortgage insurance premium.
FHA does not make loans directly to the public. An approved lender that adheres to FHA guidelines funds and services the loan. However, the government agency requires that borrowers make at least 60 months, or five years, worth of payments before the lender can cancel the mortgage insurance premium. In general, the lender usually cancels mortgage insurance after the five-year period if you made all your payments on time and meet the minimum loan-to-value, or LTV, requirement. The five-year payment requirement applies to loans with a 30-year repayment term. Loans with 15-year terms are exempt from this requirement.
In addition to making regular payments on a 30-year FHA loan, you must pay your loan's principal balance down to at least 78 percent to remove the mortgage insurance premium. The 78 percent LTV requirement is based on the lesser of the home's sales price or its appraised value at origination. A loan with a 15-year term and a 90 percent LTV at origination requires no mortgage insurance premium.
Although the FHA lender cancels the mortgage insurance automatically when the five-year and 78 percent LTV requirements are met, the insurance contract remains in force for the life of the loan. The lender can file a claim with FHA if you default on your loan after the premium requirement has been removed. If you pay down your loan ahead of schedule by paying more than the amount due each month, or by paying a lump sum to the lender to achieve the 78 percent LTV, the lender may voluntarily remove the premium.
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