Federal Housing Administration (FHA) mortgage insurance protects lenders from defaulting on loans. A default occurs when a home buyer cannot repay a home loan. The FHA is a U.S. government agency responsible for insuring mortgage loans. FHA mortgage insurance encourages lenders to lend to low- and moderate-income homebuyers because it reduces a lender's risk of losing money.
If a homebuyer is low- or moderate-income, they may be able to get an FHA home loan. A home buyer can also refinance an existing mortgage with an FHA loan. FHA does not actually forgive the loan. Instead, a private lender makes the loan and requires the homebuyer to purchase FHA mortgage insurance to qualify for the loan. In other words, if a home buyer wants a home loan, he or she must pay for FHA mortgage insurance.
Low- and moderate-income homebuyers have difficulty obtaining a home loan because they are unable to put at least 20 percent down on a home. This makes lenders reluctant to lend them money, as it is unlikely that the lender will get his money back if the buyer defaults on payment. With FHA mortgage insurance, a buyer is not required to give up 20 percent on a home. The insurance also reduces a lender's risk because the FHA pays the unpaid balance of a loan in the event of default. This gives low- and moderate-income people the opportunity to buy their own home.
The cost of FHA mortgage insurance is based on a percentage of the loan amount. The homebuyer must pay the initial premium for insurance up front. This amount is usually fed into the loan, i.e. it is added to the loan amount. After that, the homebuyer pays a monthly fee to cover the cost of FHA mortgage insurance. The monthly fee is also based on a percentage of the loan balance.
Generally, a home buyer must pay the cost of FHA mortgage insurance for at least five years. After this time, the homebuyer can cancel the FHA mortgage insurance if the buyer owes 78 percent or less of the loan. Most homebuyers can cancel insurance only if both conditions are met. The term of the home loan also affects the monthly fee for the insurance when the obligation ends. For example, a homebuyer who obtains a home loan with a term of 15 years or less may be entitled to cancel the insurance as long as he owes 78 percent or less of the loan without having to meet the five-year requirement.