When purchasing a home you’ll most likely have to borrow money from the lender to cover the cost of the home– essentially the lender takes you on as an investment. Most of the time the investment pays off but when a bankruptcy or foreclosure happens the lender loses his investment. This is where FHA mortgage insurance comes in and protects the lender against the possible loan default or foreclosure. All loans approved through FHA lenders are insured by the federal government. The cost of insuring these loans is carried through to the homeowner (you) and is the FHA mortgage insurance premium that shows up on your statement.
Why is FHA Mortgage Insurance Required?
FHA is a government program known as the Federal Housing Administration, that was formed to help more Americans purchase homes or stay in homes that were at risk of default. Unlike most government agencies, this agency does not rely on taxes or other sources pulled from the general populace. Instead it self-generates its income through the mortgage insurance that is paid monthly by homeowners with existing FHA mortgages. These payments make sure the funding is in place to reimburse a lender if a default occurs. They also keep FHA moving forward so people who can’t qualify for a loan through a conventional lender can still get into the homes that they need.
How is this Insurance Calculated?
The base percentage rate also known as the UPMIP (up front mortgage insurance premium) for FHA mortgage insurance currently stands at 1.75%. However, the rate doesn’t mean much until you know how it’s going to impact your mortgage payment. The best way to know this is to look at it hypothetically and run the calculation, which requires quite a few steps so take it little by little. You’ll need a good loan value to start with so $150,000 will do.
First, you’ll need to calculate your down payment. Both new home purchases and refinances require down payments, usually in the amount of 3.5% of the loan. The total result is $7,000 and will be paid up front for the loan, reducing your loan amount to $193,000.
Example: $200,000 * 3.5% =$5,250
$150,000 – $5,250 = $144,750.
That $144,750 is the amount that your mortgage insurance is going to be based off of. For the next step you take $144,750 and multiply it by the mortgage insurance rate of 1.75%. The total is $2,533.13.
$144,750 * 1.75% = $2,533.13
This amount is then added to the loan and financed with the loan. To calculate the financing you will take the total of $2,533.13 and divide it by 1.175 (1 + the mortgage insurance premium rate). The result is $2155.86.
$2,533.13/1.175 = $2,155.86
The amount of $2,155.86 is your annual MIP (mortgage insurance premium). To get your monthly MIP you simply divide your annual MIP by 12.
$2,155.86/12 = $179.86.
$179.86 is your estimated monthly MIP. I say estimated because as you pay down your mortgage the mortgage amount is going to change and the calculations will be adjusted accordingly. Mortgage insurance operates similar to the interest payment; as the principle goes down the payment slowly decreases.
There are plenty of additional calculations you can do to determine exactly how much you’ll be paying month by month, but this calculation should give you a ballpark idea of what you’ll be paying for your mortgage insurance.
Can I have the MIP Removed?
This is a question that many homeowners find themselves asking, especially after they compare to conventional loans and discover that the private mortgage insurance for those loans can be removed after the homeowner gets 20% equity. The short answer is no… and yes. Here’s why:
Recent changes to the FHA requirements have made the mortgage insurance permanent. All homeowners who acquire loans after June 3, 2013 are required to pay the insurance for the life of the loan. Remember, the insurance makes it possible for lenders to take on riskier investments and for more Americans to become homeowners. In order for this to happen the funding has to be coming in. So if you fall in this category, you cannot have the insurance removed from your loan.
Now those homeowners with older loans are not required to follow the new guidelines. They are ‘grandfathered’ into the programs at the original rates and with the original terms that they agreed to. For these homeowners there are situations where the insurance can be removed. Also, may different terms can be reached, including the LTV reducing to 78% or paying down the MIP for a certain amount of years. To learn whether you can have your insurance removed you’ll want to discuss with your lender the terms that were agreed upon when you signed the loan.