The Federal Housing Administration (FHA) loan program has specific insurance requirements for borrowers and lenders alike. In fact, the entire program is built around insurance — and it comes in different forms. So we’ve created a handy, all-in-one guide to FHA insurance requirements and policies.
FHA Insurance Protects Mortgage Lenders
The FHA does not lend money directly to home buyers and borrowers. With this program, the funding comes from a mortgage lender operating in the private sector (similar to other types of home loans). The difference here is that the Federal Housing Administration insures the loan against default.
But this insurance does not cover the homeowner or the property itself. It protects the lender. If a homeowner who has an FHA loan defaults (or fails to repay), the lender will be partially covered for losses by the government.
That’s a key distinction when understanding FHA insurance requirements and procedures:
- The government insurance protects the lender, not the borrower.
- But the borrower pays for the coverage, in the form of mortgage insurance premiums.
FHA insurance requirements and policies give lenders some added protection against losses resulting from borrower default. Because of this protection, the lender is exposed to less risk (when compared to a conventional or non-government-backed mortgage). So they can offer FHA loans to borrowers who might not qualify for conventional financing.
The FHA falls under the U.S. Department of Housing and Urban Development (HUD). So, in order to participate in this program, mortgage lenders must first be approved by HUD. They must also meet all of the requirements outlined in official guidelines when originating FHA loans.
When a lender is approved to originate FHA home purchase loans, they are referred to as a “Title II Mortgagee.”
According to HUD Handbook 4000.1: “A Title II Mortgagee may be approved to originate, underwrite, close, endorse, service, purchase, hold, or sell FHA Single Family insured Mortgages or multifamily Mortgages.”
Lenders typically apply for this program through an online application process, and by providing basic information relating to their business. In some cases, they must supply additional information such as business formation documents, business credit reports, financial reports, state licenses, and more.
So those are the basic FHA insurance requirements for lenders:
In order to receive coverage from the Federal Housing Administration, lenders must first be approved by the agency. In addition, they must ensure that the loans they generate meet all of requirements outlined in HUD Handbook 4000.1 (the Single Family Housing Policy Handbook) and other applicable guidelines.
But the Borrower Pays for It
This section of the guide applies to home buyers. If you plan to use this loan program to buy a property, you’ll encounter some additional FHA insurance requirements as explained below.
All borrowers who use the FHA loan program to buy a home must pay mortgage insurance premiums. These premiums are actually used to fund the entire program.
Many people believe that the Federal Housing Administration’s mortgage program is funded by taxpayers. But that’s not true. Most of the funds needed to keep the program running — and to pay the insurance claims made by lenders — come from the insurance premiums that borrowers pay.
A 2019 report from the Congressional Research Service summed it up nicely:
“FHA’s single-family mortgage insurance program is funded through FHA’s Mutual Mortgage Insurance Fund (MMI Fund). Cash flows into the MMI Fund primarily from insurance premiums [paid by borrowers] and proceeds from the sale of foreclosed homes. Cash flows out of the MMI Fund primarily to pay claims to lenders for mortgages that have defaulted.”
The above quote helps us understand why there are so many FHA insurance requirements for borrowers and lenders alike. The whole program is built on insurance. Money comes in through the premiums paid by borrowers, and is then used to cover claims made by lenders (when borrowers fail to repay their loans.)
So, the Federal Housing Administration operates more like an insurance company than a lender.
Upfront and Annual Premium Requirements
Borrowers who use this program to buy a home typically have to pay two different kinds of mortgage insurance premiums:
- There is an upfront premium that usually equals 1.75% of the base loan amount.
- There’s also an annual premium that comes to 0.85% for most borrowers (though it can be higher in some cases).
Both of these can be rolled into the loan and paid over time, as part of the monthly mortgage payment.
For most home buyers who use this program, the annual insurance cannot be removed — even if the homeowner reaches 20% equity. That’s an important distinction from conventional mortgage products, which allow homeowners to cancel their insurance policies when the loan-to-value falls to 80% or below.
As you can see, there are many FHA insurance requirements for home buyers and mortgage lenders alike.
Lenders: In order to receive insurance protection under this program, lenders must first be approved. They must also ensure that the loans they originate meet all of the requirements issued by the Federal Housing Administration and HUD.
Borrowers: Home buyers encounter FHA insurance requirements as well. They are actually the ones who fund the program, by paying the premiums mentioned above. But they are not protected by the mortgage insurance.
Homeowners / Hazard Insurance Requirements
When it comes to FHA loans, homeowners or “hazard” insurance requirements are usually dictated by the mortgage lender. After all, they are the one investing money into the property. So it’s only logical that they would require a certain level of homeowners / hazard insurance to protect that investment.
The amount of coverage that’s required can vary from one lender to the next. Most lenders will require that the home be insured for at least the loan amount. But as a homeowner, you might be better off choosing even more coverage, insuring the home for its full replacement cost.
Mortgage lenders typically require FHA borrowers to have a homeowners policy in place prior to closing. According to the Esurance website: “In most cases, you’ll be asked to provide proof that you’ve prepaid one year’s worth of coverage before the lender will consider closing.”
This article provides a basic overview of FHA insurance requirements and how the program works. To learn more, check out our article library or use the search box at the top of this page.