A conventional mortgage requires a 20% down payment. This amount can sometimes be difficult for buyers to save up so they begin looking for other options.
One very popular option is an “FHA loan” which is actually mortgage insurance provided by the Federal Housing Administration. While allowing buyers to make smaller down payments FHA loans increase the overall cost of the mortgage compared to a conventional loan.
An FHA loan has all of the closing costs any other loan type would have plus the mortgage insurance premiums. The qualification process is the same as well. Lenders still check your credit, debts, assets and income. The home will also be appraised by a licensed 3rd party appraiser.
If you are getting a standard conventional loan the appraisal should cost a little under $400. An FHA appraisal can cost up to $700. The appraiser will have to provide an opinion of value, as usual, but also verify that the home meets all of the FHA requirements. This added workload drives the price up significantly.
Also worth noting, if the home doesn’t meet those FHA guidelines repairs must be made before closing. Once the repairs are made, you will have to pay for a second inspection to verify that the house is now FHA compliant.
Mortgage insurance premium costs
FHA requires you to pay an Upfront Mortgage Insurance Premium (UFMIP) of 1.75% which gets financed into your loan. After adding the “UFMIP” on to your total loan amount, you will also get charged a yearly “MIP” premium that can range from 0.45% to 1.05% of the loan amount. This value will depend on the loan amount, loan term and down payment amount. The yearly MIP amount gets divided by 12 and is included with your monthly mortgage payment.
Placing a bigger down payment will help reduce the costs but, unlike Private Mortgage Insurance (PMI), FHA’s MIP does not fall off after you reach an 80% Loan to value ratio. You will have to pay the MIP for the entirety of the loan duration and this can add up quickly.
Methods for reducing closing costs
You most likely will not be able to reduce your closing cost to zero but you may be able to reduce the amount you pay out of pocket.
Here are a few methods to reduce your out of pocket closing costs:
- Ask the seller to pay. A seller can pay up to 6% of your FHA closing costs.
- Finance the cost into the loan. You can actually finance the FHA closing costs into a purchase loan in two ways. Either increase your interest rate and ask the lender to pay the fees or increase your loan by the amount needed to pay the fees.
Your FHA-Approved lender will have three days after you complete the loan application to provide you with an FHA loan estimate. This estimate shows you the terms and closing costs that will apply to your loan. You should keep this estimate and compare it to the final closing disclosure that you receive 3 days before closing.