What is FHA Loan Insurance?

What is FHA loan insurance exactly? When it comes to FHA loan insurance, or FHA loans in general, there seems to be some misconceptions. It won't take long but I'd like to clear some of them up for you.

First, it's important to understand a few things about FHA. FHA is short for the Federal Housing Administration which is under the Department of Housing and Urban Development (HUD). It was created during the depression as a way to stimulate homeownership.

One of the biggest misconceptions out there is that FHA loans are loans issued by the federal government. The truth is, the government is not in the business of directly giving loans to the public for housing. That's the job of banks and lenders. Instead, FHA insures a loan originated by a banker or lender. What this means is if the borrower defaults on the loan then FHA will pay the lender back.

When people understand this the next misconception is, "Oh, so my tax dollars are paying for mortgages people couldn't pay?"

Well, no.

FHA is completely independent of tax payer dollars. Anytime a borrower obtains a loan that is insured by FHA the borrow must first pay for this insurance which is called the Mortgage Insurance Premium.

Just like you have to pay for car insurance, you have to pay for mortgage insurance. The first year must be paid up front at closing and the remaining monthly payments are included in the mortgage. The amount paid is based on the purchase price of the home along with the amount of money put down.

The insurance premiums are collected in a general fund and all expenses are paid out of this fund. It's completely independent of tax payer dollars.

Finally, there is a misconception that FHA loan insurance is paid until the house is paid off. The truth is, once there is 22% equity in the home FHA loan insurance will no longer need to be paid. In many cases, it's up to the home owner to keep up with the amount of equity.

In summary, the Federal Housing Administration (FHA), which operates under HUD, offers insurance to the lender, paid for by the borrower, that in the event a borrower defaults on the mortgage FHA will pay back the lender. FHA does not produce loans directly to home buyers; it's an independent of any taxpayer dollars and doesn't have to be paid when twenty two percent equity has been reached.