Judging by the emails we’ve received lately, the FHA’s latest announcement has created a lot of confusion among home buyers. It has to do with FHA mortgage insurance premiums, and a scheduled increase that will take effect in April 2011. Here’s what you need to know:
In November of last year, the Department of Housing and Urban Development (HUD) increased the annual mortgage insurance premium for FHA home loans. They did this to bolster the FHA’s capital reserves, which shrank below congressionally mandated levels during the housing bust.
They must have run the numbers again and determined the original increase was not enough. Because they’re about to do it again. Starting this spring, the annual mortgage insurance premium (MIP) for FHA loans will rise another quarter of a percent (0.25). See “overview of increases” below for more details.
FHA Commissioner David Stevens said the latest step was needed to maintain the capital reserve requirements set forth by Congress. These reserves are used to cover losses resulting from borrower default. The FHA insures home loans against such losses. That’s the whole point of the program. Stevens said the move still allows the “FHA to remain the most cost effective mortgage insurance option for borrowers with lower incomes and lower down payments.”
Overview of Premium Increases
These changes will apply to most FHA loans that are insured after April 18, 2011. At that point, the following MIP standards will be in place:
- 30-year FHA loans will have an annual MIP of 1.1 to 1.15 percent of the loan amount.
- FHA loans with a term of 15 years or less will have an annual MIP of 0.25 to 0.50 percent.
Note that these changes only apply to the annual mortgage insurance premium for FHA loans. The upfront premium remains the same. There are two types of mortgage insurance on FHA loans: an upfront premium that gets paid at closing, and the annual premium that gets rolled into the monthly mortgage payment.
The April 2011 increase will only affect the annual premium. So the increased amount gets added onto the borrower’s mortgage payments — it’s not added to the upfront costs. In fact, the upfront insurance premium was actually decreased last year. The FHA did this to minimize the borrower’s upfront costs, while increasing the total amount of insurance paid over the term of the loan.
Don’t be confused by the similar terminology. Here’s what it boils down to. When you use an FHA home loan to buy a house, you will have to pay two forms of insurance on the mortgage loan.
- The upfront insurance premium is 1 percent of the loan amount, and you must pay it at closing (in most cases). There are currently no increases planned for the upfront portion.
- The annual premium is added onto your monthly payments. In April 2011, this premium will increase to the amounts mentioned earlier: 1.1 – 1.15 percent for 30-year loans, and 0.25 – 0.50 percent for shorter loans.
This premium increase applies to most mortgages insured under the FHA single-family loan program. But certain programs are excluded:
Mortgage Loans Not Affected by the Increase
The increase does not apply to Title I Loans (home improvement), reverse mortgages under the FHA’s Home Equity Conversion Mortgage program, or any loans made under the HOPE for Homeowners program. Additionally, the FHA mortgage insurance increase does not apply to loans made in the following areas:
- Section 247 (Hawaiian Homelands)
- Section 248 (Indian Reservations)
- Section 223(e) (Declining Neighborhoods)
- Section 238(c) (Military Impact areas in Georgia and New York)
FHA Mortgage Insurance Scenario
Here’s an example of how the FHA mortgage insurance premiums works. Let’s assume I take out an FHA home loan for $200,000. My upfront MIP is 1 percent, which in this case amounts to $2,000. I would likely have to pay this amount at closing.
My FHA loan also gets assigned an annual MIP for 1.1 percent of the loan amount. This comes out to $2,200. This is an annualized cost that is paid monthly, on top of my mortgage payment. So I can divide $2,200 by 12 and get a monthly add-on of $183.
So I’m paying around $2,000 up front, and another $183 per month. Most of this goes toward the FHA’s capital reserves. This is a realistic scenario that shows how FHA mortgage insurance works.
How to Apply for an FHA Home Loan
Mortgage insurance is just one of several requirements for the FHA loan program. You’ll also need a decent credit score (580 or higher) and a down payment of at least 3.5 percent. Additionally, your debts cannot eat up too much of your monthly income. You can learn more about these requirements here. In order to apply for an FHA home loan, you should locate an FHA-approved lender in your area. You can find such lenders on this page of the HUD website.