FHA Loans and the Insurance That Does Not Go Away

Two premiums, and only one of them is obvious

The Federal Housing Administration does not lend. It insures, and the lender lends because it is insured. That is why an FHA loan can accept a 3.5 percent down payment and a credit file a conventional underwriter would decline — the risk is not being ignored, it is being transferred to a federal insurance fund, and the fund charges for it. What makes the product confusing is that it charges in two separate places, and borrowers usually notice only one of them.

The first is the upfront mortgage insurance premium, set at 175 basis points — 1.75 percent — of the base loan amount by HUD Mortgagee Letter 2023-05, with a short list of exceptions for particular refinance and land-trust programmes. It is due at closing, and in practice almost nobody pays it at closing: it is added to the loan. The second is the annual mortgage insurance premium, quoted in basis points of the loan balance and collected in twelve monthly instalments alongside principal and interest. It is the annual one that has the duration rule, and the duration rule is the thing that decides whether an FHA loan is a bridge or a life sentence.

One thing to fix in your head before the arithmetic starts: none of this is private mortgage insurance, and the Homeowners Protection Act does not touch it. The 80 percent request and the 78 percent automatic termination that govern a conventional loan — set out in our PMI article — simply do not exist here. Paying the balance down faster does not shorten the FHA premium by a single month. The only lever is the loan-to-value ratio on the day the loan was made, and after that, refinancing.

Financing the upfront premium: what borrowing insurance costs

Take the working example and hold it fixed for the rest of the article: a $400,000 purchase, the FHA minimum 3.5 percent down, so $14,000 of cash and a base loan of $386,000 — a loan-to-value ratio of 96.50 percent. The upfront premium is 1.75 percent of that base loan: $6,755. Finance it and the actual note is written for $392,755. At 6.50 percent nominal over 30 years the annuity formula, derived in full in our article on the payment formula, gives $2,482.48 a month against $2,439.78 for the un-grossed-up $386,000. The premium therefore costs $42.70 a month.

Multiply that by the term and the number stops being small. Over 360 months you pay $15,371 for a $6,755 charge. The difference, $8,616, is pure interest on an insurance premium — you borrowed the money to buy the policy, at the mortgage rate, for thirty years. That is a 128 percent surcharge on the premium in nominal terms. It is the single most reliably overlooked line in the whole FHA comparison, because it never appears as insurance on any statement: it hides inside principal and interest, where nobody labels it.

There is a partial mitigation and it is worth knowing about rather than relying on. FHA operates a refund schedule on the upfront premium for borrowers who refinance into another FHA-insured loan within a defined window after closing, on a declining scale. It does not apply when you refinance out to a conventional loan, which is the exit most borrowers eventually take, and the schedule and its window are exactly the sort of programme detail that gets revised — check the current Handbook 4000.1 rather than a summary. Plan as though the upfront premium is sunk, and treat any refund as a bonus.

The annual premium and the rule that decides whether it ends

The annual premium is quoted in basis points and depends on three things: the base loan amount against a threshold, the loan-to-value ratio at origination, and the term. The table above reproduces the schedule for terms of more than 15 years as set out in Mortgagee Letter 2023-05. On our example — base loan $386,000, comfortably under the threshold, loan-to-value 96.50 percent, 30-year term — the rate is 55 basis points, 0.55 percent a year. Applied to the balance and divided by twelve, that is $180.01 in the first month, falling slowly as the balance falls. Over the full 30 years it totals $42,387.

The duration rule is the part that is widely misreported, so it is worth stating exactly. It comes from Mortgagee Letter 2013-04, effective for case numbers assigned on or after 3 June 2013, and it fixes the answer at origination: where the original principal obligation, excluding the financed upfront premium, is at 90 percent loan-to-value or below, the annual premium is charged for the first 11 years of the term or until the end of the term, whichever comes first; where it is above 90 percent, it is charged for the whole term. Note two things in that sentence. The comparison excludes the financed upfront premium, so the 96.50 percent in our example is calculated on $386,000 against $400,000, not on $392,755. And the test is applied once, at origination, to a number that never changes again.

The practical consequence is a cliff, and it sits at 10 percent down. Put $14,000 down on this house and the annual premium runs 360 months and totals $42,387. Put $40,000 down instead — base loan $360,000, loan-to-value exactly 90.00 percent — and the rate drops to 50 basis points and the duration to 11 years, 132 months: month one is $152.63 and the lifetime total is $18,617. That is a $23,770 difference in insurance alone, bought with $26,000 of extra deposit, before counting the interest saved on a smaller loan. If you are anywhere near 10 percent, finding the rest of it is one of the highest-return decisions in the whole transaction.

Against a conventional loan: the break-even is a rate, not a date

Run the two products side by side on identical terms: same $400,000 house, same $14,000 down, same 6.50 percent note rate, same 30 years. The FHA loan is $392,755 with 55 basis points of annual premium for the full term. The conventional loan is $386,000 at 96.50 percent loan-to-value with private mortgage insurance that, per the Homeowners Protection Act, may be cancelled on request in month 131 and terminates automatically in month 142. Everything about the comparison then turns on one number nobody quotes in a headline: the PMI rate the conventional lender's insurer would charge, which is a function of your credit file.

Solve for it and you get a clean answer. Over the full 30 years the two loans cost the same when the PMI rate is 1.264 percent a year; below that the conventional loan is cheaper, above it the FHA loan is. Over a seven-year holding period — closer to how long people actually keep a mortgage — the break-even PMI rate is 0.668 percent. Put the illustrative rates from our PMI article against those thresholds and the picture inverts depending on who you are. A borrower at 760 and above, paying perhaps 0.41 percent, is better off conventional from the first month and about $39,030 better off over the term. A borrower at 660 to 679, paying perhaps 1.15 percent, is ahead with FHA for 293 months and only loses on the full-term total by about $5,229. A borrower whose PMI is quoted above 1.264 percent never loses at all.

That is worth stating against the usual slogan, which holds that FHA wins on access and loses on cost. It wins on access, certainly. On cost the answer is conditional, and the condition points the opposite way to the slogan: FHA tends to lose on cost precisely for borrowers with strong credit, who are the ones least likely to need it, and to win on cost for borrowers with weak credit, who are the ones the programme exists for. That is not an accident — it is what a pooled, flat-rate insurance schedule does when it competes with a risk-priced private one. The correct instruction is therefore not to prefer either product but to get a real PMI quote and a real FHA quote and compare them, because the sign of the answer flips inside the ordinary range of credit scores.

The exit: refinancing out, modelled

Because the FHA premium cannot be cancelled from inside the loan, the standard way out is to leave the loan. Refinance into a conventional mortgage once you have 20 percent equity on a current appraisal, and the premium stops because the FHA insurance stops. Model it on our example. After seven years the FHA balance has fallen to $355,114; at 3 percent annual appreciation the house is worth about $491,950, so the loan-to-value ratio is 72.2 percent — comfortably inside the 80 percent a conventional lender needs to write the loan without private mortgage insurance.

The saving is exactly the premium, and it is worth being precise about that. If you refinance the remaining balance over the remaining 23 years at the same 6.50 percent, principal and interest do not change at all — it is the same schedule. What disappears is the $162.76 of monthly premium you were paying in month 85, and the $27,927 of premiums scheduled between month 85 and the end. Against that, set the refinance's own closing costs, which routinely run to several thousand dollars and are the reason this move has a threshold rather than being automatic. Divide the costs by the current monthly premium and you have the payback period; if it is under two years and you expect to stay, the refinance is straightforward.

Two traps are worth naming. The first is resetting the term. Refinancing $355,114 back over a fresh 30 years drops the payment to $2,244.56, which feels like a second saving and is not: you have added seven years of interest to escape a premium. If cash flow is not the problem, refinance over the remaining term. The second is the interest rate. This model held the rate constant to isolate the insurance; in reality the refinance happens at whatever rate exists that year, and a rate a point higher can swallow the entire premium saving. Both are the sort of thing to test with an amortisation schedule and a real quote, not with a rule of thumb — and if the rate has moved against you, staying in the FHA loan and paying the premium can genuinely be the cheaper choice.

Why continental Europe has nothing quite like an FHA loan

The FHA solves a problem every housing market has: how to lend to a household with a small deposit without either refusing it or pricing it out. What is distinctive is the solution — a federal insurance fund financed by premiums from the borrowers it serves, so the programme is self-funding and the cost is visible on a monthly statement. European systems overwhelmingly chose to solve the same problem with a guarantee rather than an insurance premium, and to place the cost on the public budget rather than on the buyer.

Spain's ICO guarantee line and Portugal's public personal guarantee under Decreto-Lei n.º 44/2024 both cover a slice of the loan so the bank can lend beyond its customary limit, and both are free to the eligible buyer; Italy's Fondo di garanzia prima casa, run by Consap, does the same for a share of the principal within a capped mortgage size. Set beside those, the FHA's design reads as a specific political choice: the borrower pays. France goes further from the model still, since the loan structure itself differs — the lender's protection is a caution or a mortgage, the borrower carries an assurance emprunteur on their own life and health, and the lending limits are set centrally by the Haut Conseil de stabilité financière rather than by a menu of insured products. Germany has no insured-loan programme of this kind at all; the state's role is delivered through subsidised lending from KfW and through tax and grant policy, while the risk of a thin deposit is priced into the interest rate.

The practical lesson for a reader outside the United States is a question rather than an equivalence. Do not ask your bank what its FHA product is; ask what raises your maximum loan-to-value ratio and what it costs, and then ask whether a public guarantee scheme applies to you. The answers vary by country, by age, by whether it is a first home and by income, and — as with every figure in this batch — the percentages and eligibility rules are revised often enough that they must be read at the source in the year you are buying.

Frequently asked questions

Can I get rid of FHA mortgage insurance by paying the loan down?

No, and this is the difference that surprises people most. The duration was fixed at origination by the loan-to-value ratio at that moment, so with under 10 percent down the annual premium is charged for the whole term regardless of what the balance does. Extra principal still saves interest, and it still brings forward the day you have enough equity to refinance out — but it does not shorten the premium by a single month. On a conventional loan with private mortgage insurance the opposite is true, which is exactly the comparison our PMI article draws.

Should I put 10 percent down on an FHA loan instead of 3.5 percent?

If you can reach exactly 90.00 percent loan-to-value, the arithmetic is emphatic. On our $400,000 example, moving from $14,000 down to $40,000 down cuts the annual premium from 55 to 50 basis points and its duration from the full term to 11 years, taking the lifetime insurance total from $42,387 to $18,617 — a saving of $23,770 on insurance alone, plus the interest saved on a smaller loan. But note that at 10 percent down you are also close to territory where a conventional loan with cancellable private mortgage insurance may beat both, so get all three quotes before deciding.

Is an FHA loan always cheaper for a buyer with weak credit?

Usually, but not automatically, and the reason is that FHA charges a flat premium while private insurers price by risk. Below a PMI rate of about 1.26 percent a year the conventional loan wins over 30 years on our example, and below about 0.67 percent it wins over seven. Weak credit tends to push the PMI quote above those lines, which is why FHA so often comes out ahead there. But the note rate can move independently, closing costs differ, and some lenders price conventional low-down-payment programmes aggressively. Two real quotes, one amortisation schedule, and the question answers itself.

Does the FHA loan limit cap what I can buy?

It caps what the FHA will insure, which in practice caps the loan rather than the purchase. The limits are set by county, are revised annually, and vary enormously between a low-cost county and a high-cost one, so the only reliable answer is the current table on HUD's own site for the county you are buying in. Note also that the base loan amount threshold that decides which annual premium band you fall into was aligned by Mortgagee Letter 2023-05 to the national conforming loan limit, which is itself reset every year — another figure to read at the source rather than from a summary.

Is there an FHA-style loan in France, Spain, Germany, Portugal or Italy?

Not in the same form. Spain, Portugal and Italy run public guarantee schemes — the ICO guarantee line, the garantia pública created by Decreto-Lei n.º 44/2024, and the Fondo di garanzia prima casa — that let a bank lend above its usual limit, but they guarantee the lender rather than selling the borrower a policy, and they are generally free to the eligible buyer. France uses a caution or a mortgage for the lender's security and an assurance emprunteur for the borrower's own risks, inside centrally set lending limits. Germany has no such insured-loan programme at all and prices a thin deposit into the interest rate, with the state acting through subsidised KfW lending instead. In all five, verify the current rules with the national authority before relying on any of this.