FHA 5 Year Rule

Understanding the FHA Loan 5 Year Rule

The FHA Loan 5 Year Rule was in place years ago when buying property using an FHA insured loan. It mandated that each FHA loan must carry mortgage insurance for a minimum of 5 years.

Essentially, this guideline impacts mortgage insurance requirements and promotes stability in the real estate market. Not only did the rule make financial sense for potential homeowners regarding property appreciation, but it also eases accessibility for individuals with various credit standings to secure home loans.

The “FHA Loan 5 Year Rule” is a guideline impacting the FHA mortgage insurance and when a homeowner can cancel it. 

Bill Gassett of Maximum Real Estate Exposure weighed in with his real estate experience. “Eric, even though FHA has changed the rules regarding the PMI cancellation policy, it remains a very popular loan program, especially among first-time home buyers.

FHA loans have allowed many borrowers purchasing my client’s homes to get into homeownership. Their low 3.5 percent down payment mortgages make it possible to buy a home when they otherwise could not.

Sometimes, these borrowers also don’t have A-plus credit scores.  FHA has more relaxed credit requirements, furthering the chance of getting into a home sooner rather than later. It is a win-win to start building equity sooner. ”

Speak with someone who can help answer your questions.

FHA 5 Year Rule: An Overview

When you take out an FHA loan, the lender is taking on more risk than they might for a conventional loan because FHA loans often have more lenient credit and financial requirements. To protect themselves, they require that a borrower pays for mortgage insurance as a safeguard.

The 5-Year Rule was an old FHA mortgage insurance rule which required borrowers to keep the insurance in place for at least 5 years and if the equity position in the home was at least 22%. The equity could be achieved by paying down the principal balance or if the home appreciated in value.

But why does this matter so much when it comes to FHA loans?

Understanding the cost implications of having mortgage insurance will help you to determine whether an FHA loan is right for you. If the only mortgage you can qualify for is FHA due to low credit or a high DTI, then you will have to live with the mortgage insurance until you are able to refinance out of it.

The New FHA Rule for Mortgage Insurance in 2024

FHA changed the rule in 2013 to remove the ability to drop the mortgage insurance after 5 years. Effective with loans dated on or after June 3, 2013, FHA loans will require mandatory mortgage insurance for the life of the loan.

According to HUD’s official communication dated January 31, 2013, the change was made to “strengthen the mutual mortgage insurance fund”.  The reason why they needed to strengthen the fund is likely due to the record number of foreclosures following a huge market decline in 2008. When a home with an FHA loan is foreclosed upon, the cost difference must be covered by the fund.

Exception to the rule: If you put at least 10% down when purchasing the home or have at least 10% equity when refinancing into an FHA loan, the mortgage insurance can be cancelled after 11 years from the date of the FHA loan.

FHA Implications for Borrowers

FHA loans offer an important opportunity for individuals who might not qualify for conventional loans to achieve homeownership. The relaxed credit score and down payment requirements make it easier for people to secure a mortgage and buy a home, even if they don’t meet the strict criteria set by traditional lenders. This is particularly beneficial for first-time homebuyers, individuals with lower income, or those who have experienced financial setbacks in the past.

However, it’s important for borrowers to understand that these benefits come with some trade-offs. While FHA loans provide access to homeownership with lower credit scores and smaller down payments, borrowers may encounter the additional mortgage insurance as part of their payment.

Both the upfront and ongoing mortgage insurance premiums (MIP) contribute to the overall expenses of owning a home.

An FHA loan is like a bridge that helps individuals cross over barriers created by stricter conventional mortgage requirements. Understanding the difference between the two loans helps borrowers to make well-informed decisions about pursuing an FHA loan, taking into account both the immediate benefits and long-term financial considerations.

5 Year Rule FAQ

What happens if a borrower violates the 5-year rule for FHA loans?

Borrowers are unable to violate the rules about mortgage insurance cancellation because the lender and loan servicer controls the payment requirement.

Are there any potential benefits to waiting for the 5-year period before refinancing an FHA loan?

There are no specific benefits for waiting 5 years before refinancing. Each refinance situation needs to be evaluated independently. It comes down to whether there is a net tangible benefit to refinancing your mortgage at that moment. Things to consider are whether you are getting a lower interest rate, lower payment, ability to cash out equity, or better term on the mortgage.

Are there any exceptions or exemptions to the 5-year rule for FHA loans?

There were no exceptions to the 5 year rule when it existed and under the new FHA rule for mortgage insurance, there are no exceptions.

What is the purpose of the 5-year rule for FHA loans?

The purpose of the 5 year rule was to establish guidelines on when the FHA mortgage insurance could be cancelled.

How does the 5-year rule affect borrowers with FHA loans?

The 5-year rule significantly affected borrowers with FHA loans by stipulating that they must wait at least five years before being eligible to remove the mortgage insurance premium (MIP) from their loan. This means that borrowers will had to continue paying MIP for a longer period, resulting in additional costs.

According to recent statistics, the average MIP payment for FHA loans is estimated to be around $100 to $200 per month, which can add up to thousands of dollars over the five-year period and even more based upon today’s new guidelines.

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