FHA Mortgage 101: Mortgage Insurance
By: Vanessa Rodriguez
August 6, 2010 (FreeRateUpdate.com) – The Federal Housing Administration insures mortgage loans originated by FHA-approved mortgage lenders. The FHA sets qualification guidelines for mortgage loans with better terms. Approved mortgage lenders agree to the set guidelines because the FHA requires borrowers to purchase mortgage insurance. The insurance protects lenders against loan default.
FHA mortgage insurance is required for any FHA loan, notwithstanding the loan and down payment amounts. For this insurance, FHA borrowers pay an upfront mortgage insurance premium either in cash at close of escrow or it can be wrapped into the loan amount. In addition to the mortgage insurance premium, borrowers are responsible for an annual mortgage insurance premium, which is to be paid monthly. Regardless of the loan to value ratio, the monthly insurance payment must be paid for at least five years, which is a total of sixty months. If the loan to value ratio is 78% or less after the minimum five year requirement, then the annual mortgage insurance premium will automatically cancel. Automatic cancellation is based on the amortization schedule and does not account for any extra payments. If borrowers have made additional payments to principal, then they must contact their lender to discuss cancellation. The cancellation policy applies to loans with terms of 15 years or less and an LTV of 90% or more. The policy does not apply to loans with a 15 year term and an LTV of 89.99% or less because they are not charged annual mortgage insurance premiums.
Although all FHA loans require mortgage insurance, private mortgage insurance provides protection for the conventional mortgage market. If 80% of the purchase price is borrowed, then private mortgage insurance is required. FHA mortgage insurance is much less costly, as much as 10% less, than private mortgage insurance particularly for borrowers with poor to moderate credit and less than 22% home equity. Private mortgage insurance premiums heavily weigh credit scores and credit history. If a borrower has a credit score less than 620, then he or she can expect an exuberant spike in insurance premiums, sometimes as high as 5% of the loan amount.
Last Friday, Congress passed a bill that allows the Federal Housing Administration flexibility with regards to the mortgage insurance premiums charged to borrowers. The FHA Commissioner, David Stevens, announced changes to both the FHA upfront and annual mortgage insurance premiums. As of April of this year, the upfront premium increased from 1.75% of the total loan amount to 2.25% of the total loan amount. This translates into a $500 increase for every $100,000 borrowed. The annual mortgage insurance premiums for most FHA loans were 0.55% of the total loan amount. Congress has granted the Federal Housing Administration to increase those levels to 1.55% of the loan amount and President Barrack Obama is expected to sign the bill into law.
The mortgage loan crisis caused most Americans to depend on the Federal Housing Administration for reliable funding. According to Stevens, FHA loans have an unhealthy market share; American dependence has increased FHA loans from three percent in previous years to over twenty-five percent today. Last year, an audit revealed that FHA attained capital reserves of .53 percent. Congress mandates that the Federal Housing Administration maintain 2 percent capital reserves. The increase in mortgage insurance premiums will increase capital reserves. The FHA estimates an additional $300 million a month attributed to changes to the mortgage insurance premiums, which is estimated to cost borrowers an extra $42 a month.
Although changes to the FHA mortgage insurance premiums increases costs to borrowers, FHA loans are a better option over conventional financing. Consider the upfront private mortgage insurance premium could amount to as much $5,000 on a $100,000 loan, whereas under new FHA regulations the upfront premium would be $2,250 on a $100,000.