Case Study: Understanding the Difference in Mortgage Insurance for Conventional and FHA Loans

Brian Davis By Brian Davis

Here at Simply Home Lending, we are often faced with this question from our borrowers: Should I choose a conventional loan or an FHA loan? The focus of this case study will be on one of the main differences between these two types of loans: mortgage insurance.

Mortgage insurance (MI) is an insurance policy which compensates the lender for losses due to the default of a mortgage loan. MI is typically paid monthly as part of the borrower’s mortgage payment and can have an upfront premium paid at closing, depending on the loan type. Below are the main differences between conventional and FHA loans in regards to mortgage insurance.

Conventional Loans:

  • MI is required on loans when the down payment is less than 20%
  • No upfront premium must be paid at closing
  • Monthly MI premium is automatically removed once the balance of the loan is paid down below 78% of the original purchase price or appraised value, whichever is lower
  • After two years, the borrower has the option to get the property re-appraised, and if the current balance on the loan is less than 80% of the new appraised value, the MI can be removed
  • Monthly mortgage insurance premiums on conventional loans are typically 30% – 50% lower than FHA MI premiums
  • MI premiums vary based on credit score, amount of down payment and length of the loan
    • Higher credit scores, larger down payments and shorter loan terms (15 years) will have lower monthly MI premiums

FHA Loans:

  • MI is required on all FHA loans regardless of down payment amount
  • Upfront premium of 1.75% of the base loan amount is charged at closing
  • Monthly MI premium cannot be removed for the life of the loan if the down payment is 10% or less; for down payments greater than 10%, the monthly MI premium can be removed after 11 years
  • No option to have the property re-appraised after two years in order to drop the monthly MI premium
  • Monthly premiums vary based on the amount of the down payment from 0.80% – 0.85% annually for 30 year loans
  • Monthly premiums vary based on the amount of the down payment from 0.45% – 0.70% annually for 15 year loans

When taking the information above into consideration, one might ask: Why should I choose an FHA loan over a conventional loan? There are a few reasons why an FHA loan may be the best option for you. First, the minimum down payment on an FHA loan is 3.5% as opposed to 5% on a conventional loan. Second, interest rates are typically lower on FHA loans than on conventional loans. Third, FHA loans are more lenient towards borrowers with lower credit scores and higher debt to income ratios, i.e., those who may not qualify for a conventional loan.

The best way to determine which type of loan best fits your needs is to contact one of Simply Home Lending’s knowledgeable loan officers. They will help guide you through the mortgage process and show you all of the options available for your specific loan needs.