As compared to conforming mortgages and jumbo loans, Federal Housing Administration (FHA)-backed loans are popular for several reasons.
The FHA allows a 3.5% downpayment
The FHA allows refinances without appraisal
FHA mortgage rates are usually very low
However, one place FHA mortgages can fall short is with respect to mortgage insurance.
As compared to conventional mortgages, USDA loans and VA loans, FHA mortgage insurance premiums (MIP) can be cumbersome and costly.
If you're using an FHA-backed mortgage for an upcoming home purchase or refinance, you'll want to know how your MIP works, and how to cancel your FHA MIP when you're ready.
How FHA Mortgage Insurance Premiums Work
The Federal Housing Administration's role in mortgages is different from the role of Fannie Mae and Freddie Mac. The FHA doesn't "buy mortgages" from banks like Fannie and Freddie do to create market liquidity. Rather, the agency is an insurer of mortgages.
It works like this : The Federal Housing Administration publishes official mortgage guidelines to which banks can choose to underwrite a mortgage. Mortgages which meet these published guidelines can be insured. Loans which the agency insures are typically known as "FHA mortgages".
The Federal Housing Administration is a backstop to the banks. Should your loan ever go into default, the FHA is there is to repay the bank's loss, much like a auto insurer pays a claim due to accident.
Federal Housing Administration is mostly self-funded. Default claims are paid from a fund called the Mutual Mortgage Insurance (MMI) fund which is populated via two types of mortgage insurance premiums paid by FHA-backed borrowers.
The two types of premiums are the FHA Upfront Mortgage Insurance Premium (UFMIP), and the FHA annual Mortgage Insurance Premium (MIP). All FHA-insured homeowners pay both insurance types.
The Federal Housing Administration's mortgage insurance requirements vary by loan type and length.
FHA Upfront Mortgage Insurance Premiums
The FHA's current upfront mortgage insurance premium (UFMIP) is 1.75 percent of your loan size. For example, if you use an FHA-backed mortgage for a purchase mortgage and your loan size is $300,000, then your Upfront MIP will be 1.75 percent of $300,000, or $5,250.
The good news is that Upfront MIP is not paid as cash. Upfront MIP is automatically added to your loan balance by the Federal Housing Administration. With the same $300,000 loan size, then, accounting for Upfront MIP, your actual borrowed amount will be $305,250.
Note that Upfront MIP does not affect your loan's loan-to-value (LTV) calculation. You can make a 3.5% downpayment on your purchase, add the UFMIP to your borrowed amount, and still meet the FHA's minimum downpayment guidelines.
The 1.75% Upfront MIP is collected at closing and paid into the Mutual Mortgage Insurance fund. You'll never be asked to pay it again. This is why it's called "upfront" MIP.
However, if you refinance your FHA mortgage within the first 36 months of closing, the government will give you an upfront MIP refund on your "unused" MIP portion. The refund is based on your original Upfront MIP payment, and decreases by 2 percentage points annually until no money remains to be refunded.
The second type of Federal Housing Administration mortgage insurance is the FHA's annual Mortgage Insurance Premium (MIP). Annual MIP is paid in 12 installments per year, and is included in your monthly mortgage payment.
On your monthly mortgage statement, FHA MIP is a line-item, often listed as "HUD Escrow", "Risk-Based HUD", or "Monthly Mortgage Insurance". It's rarely shown as "FHA mortgage insurance"
Annual MIP is required for all FHA mortgages. The size of your premium will depend on your loan's specific characteristics. As of March 27, 2014, annual FHA MIP rates are as follows:
15-year loan terms with loan-to-value over 90% : 0.70 percent annual MIP
15-year loan terms with loan-t0-value under 90% : 0.45 percent annual MIP
30-year loan terms with loan-to-value over 95% : 1.35 percent annual MIP
30-year loan terms with loan-to-value under 95% : 1.30 percent annual MIP
FHA borrowers can also expect an additional 0.25 percentage point premium on loans exceeding $625,500, but less than $729,750. Such "jumbo FHA loans" are available in high-cost areas only, where the median home sale price handily exceeds the national average.
Also, note that annual MIP cannot exceed 1.55 percent by law.
Do You Qualify For The FHA MIP Exception?
FHA mortgage insurance rates have climbed 6 times in six years. However, there is a large group of FHA-backed homeowners for whom mortgage insurance rates remain ultra-low.
Several years ago, to help U.S. homeowners capitalize on the lowest mortgage rates of a lifetime, the FHA passed a rule exempting long-standing FHA homeowners from increases to the FHA MIP.
If your current FHA loan was endorsed on, or before, May 31, 2009, you can refinance for cheap.
For such "grandfathered" borrowers, upfront mortgage insurance premiums drop for 1.75 percent to just 0.01%, or $10 per $100,000 borrowed.
In addition, annual MIP rates drop from a maximum of 1.55 percent to just 0.55%, lowering an FHA loan's "effective" mortgage rate by a full percentage point. Premiums are the same across all 15-year and 30-year mortgages, regardless of LTV.
How To Get Rid of Your FHA MIP
FHA mortgage insurance is never permanent. It can either go away on its own, or you can refinance it away.
For homeowners whose FHA mortgage pre-dates June 3, 2013, MIP goes away when certain conditions are met:
30-year loan term : Annual MIP is automatically canceled once the loan reaches 78% loan-to-value and annual MIP has been paid for at least 60 months.
15-year loan term : Annual MIP is automatically canceled once the loan reaches 78% loan-to-value. There is no requirement for MIP to be paid for at least 60 months.
Homeowners should not that LTV calculations are based on the FHA's last known value of the home -- not its current appraised value. For many people, the "last known value" is the value of the home at the date of purchase; the last time the home was FHA-appraised.
For some quick math, a 30-year FHA mortgage with 3.5 percent downpayment will reach 78% LTV in roughly 11 years. A 15-year fixed with 3.5 percent down would reach 78% LTV in just over two years.
However, you can end your MIP sooner.
Home values have been rising since 2011 and it's given FHA-backed homeowners a veritable home equity boost. Rather than using the FHA Streamline Refinance which required today's new, higher premiums, savvy homeowners have "refinanced out" from the FHA.
With as little as 5% equity, homeowners are finding it cheaper to refinance into a conventional loan from Fannie Mae or Freddie Mac. Mortgage insurance rates are lower via Fannie and Freddie, and insurance payment cancel once the home gets 20% equity.
The math gets even better as your home equity levels increase.
With an FHA loan, MIP rates are flat. Via Fannie Mae or Freddie Mac, though, rates decrease along with your LTV. Unless your loan is grandfathered, ditching the FHA for conventional can be the best way to lower your payment and cancel your MIP.
FHA mortgage rates are cheap, but the associated premiums are not. FHA MIP can be costly and can add to your long-term housing costs. Thankfully, you have options.
Homeowners with FHA loans from May 31, 2009 or prior can use the FHA Streamline Refinance to get access to ultra-low rates and ultra-low premiums. It's a terrific deal for those who want it. Everyone else can look to conventional loans where rates are low and premiums are cheap.
Janus Mortgage Corporation is a mortgage broker licensed in the State of California, under the auspices of the California Bureau of Real Estate license number 02038085 and the National Mortgage License Registry NMLS Number 1690954, . All offers for loan programs are made for loans on California properties only.