Loan Modification

Should you pay FHA up-front insurance in cash?

By Peter G. Miller

It was last September when HUD lowered the up-front premium for FHA loans. Instead of an up-front mortgage insurance premium (MIP) equal to 2.25 percent of the mortgage amount, new FHA loan requirements lowered the up-front premium to 1.00 percent. At the same time, the annual mortgage insurance premium was increased from .55 percent of the outstanding loan balance to .90 percent for most FHA borrowers.

FHA borrowers can pay the up-front fee in cash or by adding it to the loan amount, options which raise an interesting question: Does it ever make sense to pay that up-front MIP in cash?

Let’s imagine that you borrow $200,000 at 4.75 interest. Add on the up-front MIP — $2,000 in this case — and the loan amount increases to $202,000.

In terms of monthly payments the choices look like this:

You pay $2,000 up front and your monthly payment for principal and interest for a $200,000 mortgage is $1,043.29.

Or, you add the up-front MIP to the mortgage amount. Now your monthly payment increases to $1,053.73.

In other words, NOT paying $2,000 up front increases your monthly payment in this example by $10.44 or $125.28 a year.

For most situations, especially FHA loans for people with bad credit, the choice is overwhelmingly clear: Fold the up-front MIP into the loan amount.

Why?

Well, it’s easier for most people to come up with $10 a month than $2,000 at one time. Also, when people are buying a home there are a lot of demands for cash in terms of down payments, moving expenses and closing costs. The ability to defer $2,000 in expenses is a big deal for most purchasers.

In addition, $2,000 divided by $125 means it will take 16 years to pay out $2,000. That’s not counting the possible interest that could be earned on $2,000 nor does it look at taxes and inflation. And guess what? Few FHA loans — or any other loans — remain outstanding 16 years.

But what about a situation where interest rates are higher, say 7.5 percent? Does the argument change?

If you borrow $200,000 at 7.5 percent the monthly cost for principal and interest is $1,398.43.

The same rate for a $202,000 loan will cost $1,412.41 per month.

Now the monthly difference in costs is $13.98 a month or $209.70 per year.

But again the same problems exist. Getting an extra $13 a month is pocket change, writing a check for another $2,000 is far more difficult.

The bottom line reality is that FHA guidelines allow borrowers to obtain financing with very little down. You absolutely need that 3.5 percent down payment money (or a gift), but beyond that the MIP is a non-issue, at least in cash terms.

So why is the ability to finance the up-front MIP important?

The real estate marketplace is a mess in many if not most metro areas. The only way housing values will be restored is if demand for real estate increases. Demand will (hopefully) increase as a by-product of population growth, as
unemployment levels (hopefully) go down and (hopefully) the economy improves. Whether these events happen or don’t happen in the short term, it surely helps to have fewer cash costs at closing.

Full post as published by FHA Mortgage Guide on January 03, 2011 (boomark / email).