Loan Modification

Will You Benefit From The New FHA Insurance Premiums?

By Peter G. Miller

As we reported last week, beginning September 7th there will be a new schedule for FHA mortgage insurance premiums made after that date. In basic terms, the upfront premium will decline from 2.25 percent to 1.0 percent and the annual fee will increase from .55 to as much as .90 percent.

All of this raises a question: If the FHA expects to raise an additional $300 million per month with the new program — and it does — are borrower costs rising by $300 million? The answer has to be yes, but the increase may be a lot less per loan than most people anticipate.

Here’s why:

To understand what’s going on let’s imagine that you get a $200,000 fixed-rate FHA loan. Let’s also say that the loan lasts seven years — which, as it happens, is a typical loan term before an FHA mortgage is paid off, refinanced or erased as part of a home sale. The loan is a 30-year mortgage at 5 percent.

Under the old schedule there would be a 2.25% fee up front — that’s $4,500 that must be paid in cash or added to the loan amount. Over a period of seven years the loan balance goes from $200,000 to $179,871. In other words, the average amount outstanding over seven years is $189,935. With a mortgage insurance premium of .55 percent per year, it means the total cost for the annual mortgage insurance premium, the MIP, is $7,312. Add the up-front fee and the annual fee over seven years and the total cost for FHA loan insurance under the current system will be $11,812.

Under the schedule for loans made on September 7th and thereafter, the up-front fee for the same loan will be $2,000. The annual MIP, .90 percent, will be $11,966 or a total for FHA financing of $13,966.

Timing

There’s no doubt that $13,966 is bigger than $11,812. The difference is $2,154 — that’s $307.71 annually for seven years or an effective additional cost of $25.64 per month.

However, one must also consider several additional matters when comparing the old premium schedule with the new one.

First, under today’s plan the big money is due up front — that’s precisely the time when buyers, especially first-time buyers, are least likely to have wads of cash and least likely to afford a loan made larger by the addition of the up-front MIP. By lowering the up-front insurance cost HUD has made the FHA home loan a lot more practical for many marginal borrowers.

Second, the insurance requirement might not last for seven years. The FHA allows borrowers to end their insurance payments after five years if the value of their loan is less than 78 percent of the property’s value.

“For mortgages with terms more than 15 years,” says HUD, “the MIP will be terminated when the Loan to Value (LTV) ratio reaches 78%, provided the borrower has paid the MIP for at least five years. If the LTV reaches 78% and the borrower has not paid MIP for at least five years then the borrower must continue to pay MIP until the five year requirement is met. ”

That means monthly MIP payments for two years — about $3,400 in this example — can be lopped off borrower costs if property values rise and loan balances fall. That’s not going to happen everywhere, but where values begin to turn around you can expect a number of future FHA borrowers to enjoy lower insurance costs when compared with those who have financed under today’s formula.

Full post as published by FHA Mortgage Guide on August 09, 2010 (boomark / email).