Understanding the FHA Mortgage Insurance Premium (MIP)

* Disclaimer – all information in this article is accurate as of the date this article was written *

The FHA Mortgage Insurance Premium is an important part of every FHA loan.

There are actually two types of Mortgage Insurance Premiums associated with FHA loans:

1.  Up Front Mortgage Insurance Premium (UFMIP) – financed into the total loan amount at the initial time of funding

2.  Monthly Mortgage Insurance Premium – paid monthly along with Principal, Interest, Taxes and Insurance

Conventional loans that are higher than 80% Loan-to-Value also require mortgage insurance, but at a relatively higher rate than FHA Mortgage Insurance Premiums.

Mortgage Insurance is a very important part of every FHA loan since a loan that only requires a 3.5% down payment is generally viewed by lenders as a risky proposition.

Without FHA around to insure the lender against a loss if a default occurs, high LTV loan programs such as FHA would not exist.

Calculating FHA Mortgage Insurance Premiums:

Up Front Mortgage Insurance Premium (UFMIP)

UFMIP varies based on the term of the loan and Loan-to-Value.

For most FHA loans, the UFMIP is equal to 2.25%  of the Base FHA Loan amount (effective April 5, 2010).

For Example:

>> If John purchases a home for $100,000 with 3.5% down, his base FHA loan amount would be $96,500

>> The UFMIP of 2.25% is multiplied by $96,500, equaling $2,171

>> This amount is added to the base loan, for a total FHA loan of $98,671

Monthly Mortgage Insurance (MMI):

  • Equal to .55% of the loan amount divided by 12 – when the Loan-to-Value is greater than 95% and the term is greater than 15 years
  • Equal to .50% of the loan amount divided by 12 – when the Loan-to-Value is less than or equal to 95%, and the term is greater than 15 years
  • Equal to .25% of the loan amount divided by 12 – when the Loan-to-Value is between 80% – 90%, and the term is greater than 15 years
  • No MMI when the loan to value is less than 90% on a 15 year term

The Monthly Mortgage Insurance Premium is not a permanent part of the loan, and it will drop off over time.

For mortgages with terms greater than 15 years, the MMI will be canceled when the Loan-to-Value reaches 78%, as long as the borrower has been making payments for at least 5 years.

For mortgages with terms 15 years or less and a Loan -to-Value loan to value ratios 90% or greater, the MMI will be canceled when the loan to value reaches 78%.  *There is not a 5 year requirement like there is for longer term loans.

_________________________________

Related Articles – Mortgage Approval Process:

Should I Refinance or Get a HELOC For Home Improvements?

For homeowners interested in making some property improvements without tapping into their savings or investment accounts, the two main options are to either take out a Home Equity Line of Credit (HELOC), or do a cash-out refinance.

According To Wikipedia:

A home equity line of credit is a loan in which the lender agrees to lend a maximum amount within an agreed period, where the collateral is the borrower’s equity. 

A HELOC differs from a conventional home equity loan in that the borrower is not advanced the entire sum up front, but uses a line of credit to borrow sums that total no more than the credit limit, similar to a credit card.

HELOC funds can be borrowed during the “draw period” (typically 5 to 25 years). Repayment is of the amount drawn plus interest.

A HELOC may have a minimum monthly payment requirement (often “interest only”); however, the debtor may make a repayment of any amount so long as it is greater than the minimum payment (but less than the total outstanding).

Another important difference from a conventional loan is that the interest rate on a HELOC is variable. The interest rate is generally based on an index, such as the prime rate. This means that the interest rate can change over time. Homeowners shopping for a HELOC must be aware that not all lenders calculate the margin the same way. The margin is the difference between the prime rate and the interest rate the borrower will actually pay.

A Home Equity Loan is similar to the Line of Credit, except there is a lump sum given to the borrower at the time of funding and the payment terms are generally fixed. Both a Line of Credit and Home Equity Loan hold a subordinate position to the first loan on title, and are typically referred to as a “Second Mortgage”. Since second mortgages are paid after the first lien holder in the event of default foreclosure or short sale, interest rates are higher in order to justify the risk and attract investors.

Measuring The Different Between HELOC vs Cash-Out Refinance:

There are three variables to consider when answering this question:

1.  Timeline
2.  Costs or Fees to obtain the loan
3.  Interest Rate

1. Timeline –

This is a key factor to look at first, and arguably the most important. Before you look at the interest rates, you need to consider your time line or the length of time you’ll be keeping your home.  This will determine how long of a period you’ll need in order to pay back the borrowed money.

Are you looking to finally make those dreaded deferred home improvements in order to sell at top dollar? Or, are you adding that bedroom and family room addition that will finally turn your cozy bungalow into your glorious palace?

This is a very important question to ask because the two types of loans will achieve the same result – CASH — but they each serve different and distinct purposes.

A home equity line of credit, commonly called a HELOC, is better suited for short term goals and typically involves adjustable rates that can change monthly. The HELOC will often come with a tempting feature of interest only on the monthly payment resulting in a temporary lower payment. But, perhaps the largest risk of a HELOC can be the varying interest rate from month to month. You may have a low payment today, but can you afford a higher one tomorrow?

Alternatively, a cash-out refinance of your mortgage may be better suited for securing long term financing, especially if the new payment is lower than the new first and second mortgage, should you choose a HELOC. Refinancing into one new low rate can lower your risk of payment fluctuation over time.

2. Costs / Fees –

What are the closing costs for each loan?  This also goes hand-in-hand with the above time line considerations. Both loans have charges associated with them, however, a HELOC will typically cost less than a full refinance.

It’s important to compare the short-term closing costs with the long-term total of monthly payments.  Keep in mind the risk factors associated with an adjustable rate line of credit.

3. Interest Rate –

The first thing most borrowers look at is the interest rate. Everyone wants to feel that they’ve locked in the lowest rate possible. The reality is, for home improvements, the interest rate may not be as important as the consideration of the risk level that you are accepting.

If your current loan is at 4.875%, and you only need the money for 4-6 months until you get your bonus, it’s not as important if the HELOC rate is 5%, 8%, or even 10%. This is because the majority of your mortgage debt is still fixed at 4.875%.

Conversely, if you need the money for long term and your current loan is at 4.875%, it may not make financial sense to pass up an offer on a blended rate of 5.75% with a new  30-year fixed mortgage.  There would be a considerable savings over several years if variable interest rates went up for a long period of time.

…..

Choosing between a full refinance and a HELOC basically depends on the level of risk you are willing to accept over the period of time that you need money.

A simple spreadsheet comparing all of the costs and payments associated with both options will help highlight the total net benefit.

_________________________________

Related Article – Refinance Process: