How Does Mortgage Insurance Affect the Choice of FHA Mortgages
FHA mortgages are a solid choice for many homebuyers, especially for first-time buyers and those trying to get a home mortgage with lower downpayments. The rates can be more competitive than conventional loans and VA loans. The terms can be more advantageous.
However, great perks don’t come free. Mortgages in general require mortgage insurance when the downpayments are less than 20 percent of the principal. FHA mortgages are no exception. FHA home borrowers having minimum downpayments or less than 20 percent are also required to pay mortgage insurance premiums.
Last year, a bill was signed by the president, making new requirements on FHA mortgage insurance. Some homebuyers are subject to these changes but some are exempt from them.
For home buyers planning to secure a FHA home mortgage, these changes have impact on their choice. For instance, which one will be more advantageous, the 15-year FHA mortgage or the 30-year FHA mortgage?
FHA mortgage insurance
FHA insures mortgages by issuing guidelines that banks can underwrite to a mortgage rather than buying mortgages from banks. The mortgages insured in this way are termed as FHA mortgages. When a FHA mortgage defaults, FHA is responsible for repaying the bank that underwrites the mortgage. That money comes from the FHA capital reserves that are funded by the insurance premiums paid by FHA homeowners.
FHA homeowners pay two types of mortgage insurance
- Upfront Mortgage Insurance Premiums (UPMIP)
Premiums are paid upfront to FHA at closing. UPMIP is automatically added to the loan principal, instead of being paid as cash. As a result, homeowners are to pay the interest for the lifetime of the mortgage just as the original loan balance.
It is neither taken into account in the FHA loan-to-value calculation. That is to say homeowners are still able to meet the FHA low downpayments guidelines even they have increased total loan amount added by the mortgage insurance premiums.
- Annual Mortgage Insurance Premiums (MIP)
Though called Annual MIP, they are paid monthly as a part of the mortgage statement. The premiums vary from FHA mortgages to FHA mortgages. FHA issues different guidelines regarding to 30-year mortgages and those shorter than 30 years. And the premiums vary based on the loan-to-value ratio of a specific FHA mortgage.
Increase to FHA mortgage insurance premiums
Increase has been required to both UPMIP and Annual MIP.
- Increase to UPMIP
Effective for all FHA mortgages dated on or after Apr 9th, 2012, the UPMIP is increased from 1.0 percent to 1.75 percent of the base loan amount. The increase applies to all case numbers despite of the specific term on amortization or loan-to-value ratio.
Here is a real-life example. Since UPMIP is 1.75 percent of the loan size, it will be 7,000 dollars for a 400,000-dollar FHA mortgage. And the total mortgage size will be 407,000 dollars.
- Increase to Annual MIP
On Dec 23rd, 2011, a bill requiring FHA to increase the Annual MIP by 10 basis points was signed by President Barack Obama. The increase is effective for FHA mortgages that are dated on or after April 9th 2012.
Since Annual MIP vary according to the loan term and loan-value ratio, they will be
1) 0.6 percent for 15-year mortgages with loan-to-value ratio over 90 percent
2) 0.35 percent for 15-year mortgages with loan-to-value ratio below 90 percent
3) 1.25 percent for 30-year mortgages with loan-to-value ratio over 95 percent
- Increase to FHA Annual MIP for mortgages over 625,000 dollars
An additional 25 basis points is added to mortgages with base loan amount over 625,000 dollars. The increase is effective for all case numbers dated on or after June 11th, 2012.
How does the increase affect 15-year FHA mortgage and that of 30-year?
UFMIP is calculated as a part of the loan size, therefore they are not related to the loan terms. It is the Annual MIP that should get the attention of homebuyers. And one thing homeowners should know is that Annual MIP can be canceled if
- The outstanding balance reaches 78 percent loan-to-value and the Annual MIP have been paid for at least 60 months on a 30-year mortgage.
- The outstanding balance reaches 78 percent loan-to-value on a 15-year mortgage. Homeowners are not required to pay the Annual MIP for at least 60 months.
That is to say, homeowners of a 30-year FHA mortgage can get rid of the Annual MIP only when a) they have paid the insurance for at least five years (60 months), and b) the loan-to-value ration is below 87 percent. But with a 15-year FHA mortgage, the Annual MIP can be canceled as soon as the loan-to-value ratio hits 78 percent. There is no specific requirement as to how long homeowners have to pay the insurance.
In addition, the Annual MIP is higher with 30-year mortgages than with 15-year mortgages. Therefore, in the long run, the Annual MIP may cost more if the loan term is longer.
In these aspects, it seems that 15-year FHA mortgages are more advantageous. And it is true. It can’t be better if homeowners are able to get a 15-year mortgage. And before signing on 30-year FHA mortgages, homeowners should shop around and see if they can strike a better deal. It is the shared wish that mortgage could be paid as soon as possible with better terms.
However, it must be understood that for a loan size of 300,000 dollars, the monthly payments on 15-year FHA mortgages may get more aggressive than on 30-year mortgages. The advice is that homeowners should do some calculations to see if they are able to afford heavy monthly payments for at least 15 years. If money is a problem and the financial situation shows no sign of improvement in the near future, the 30-year mortgage may prove more advantageous in the long run.
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