We’ve all heard of private mortgage insurance (PMI). You know, that pesky periodic insurance premium that mortgage borrowers are required to pay when securing conventional mortgages, the loan-to-values (LTVs) of which are above 80%. But about what should the loan originator know pertaining to PMI’s cousin the FHA Mortgage Insurance Premium (MIP)?
Although both types of mortgage insurances, PMI and MIP, insure the loan’s investor against the borrower defaulting, PMI is only and always associated with conventional mortgage loans and is typically required when a conventional loan’s loan-to-value exceeds 80%. Mortgage Insurance Premium, however, is always and only associated with FHA loans. FHA Mortgage Insurance manifests in two forms: the Annual Mortgage Insurance Premium (AMIP) and the Upfront Mortgage Insurance Premium (UFMIP). With the exception of Reverse Mortgages and Hawaiian Home Lands Loans, all FHA loans are required to carry both types of MIP.
MIP Type – Annual Mortgage Insurance Premium (AMIP)
At the beginning of the applicable FHA loan, the lender identifies the FHA loan’s original LTV and loan term. It then cross-references those two components on an FHA-published chart. Where those two factors meet on that chart is the AMIP factor. This AMIP factor can range between 45 – 105 basis points (bps) depending on the FHA loan’s initial LTV and loan amount. Most FHA loans require an AMIP factor of 85 basis points.
At the FHA loan’s origin, and then every December thereafter, the lender or mortgage servicer multiplies the loan’s outstanding balance by the applicable AMIP factor resulting in the annual mortgage insurance premium. This AMIP is then divided into twelve equal payments and then incorporated into the borrower’s monthly payments during the following calendar year. As the loan’s balance reduces annually, so will the AMIP premium.
Imagine that an FHA’s base loan amount (to be defined shortly) is $200,000. If the applicable AMIP factor is 85 bps, the monthly AMIP will be $141.66. To derive this premium amount, the lender multiplies the $200,000 loan balance by the 0.85% AMIP factor resulting in the annual mortgage insurance premium of $1,700. This annual mortgage insurance premium is then divided into its monthly equivalence of $141.66 which is incorporated into the borrower’s monthly mortgage payment.
Unlike PMI, of which the borrower can request the removal once their loan reaches 80% LTV, AMIP removal is contingent on the borrower’s initial down payment. If this down payment is 10% or greater, the mortgage servicer must automatically remove the AMIP after the FHA loan’s eleventh year. If, however, the borrower’s initial down payment is less than 10%, AMIP becomes a life-of-loan requirement. Of course the borrower may explore refinancing his or her loan into a non-FHA product once he or she achieves 20% or more equity in the property, but doing so involves cost and qualification.
MIP Type – Upfront Mortgage Insurance Premium (UFMIP)
The Upfront Mortgage Insurance Premium is a one-time premium that is typically incorporated directly into the FHA mortgage’s loan amount. I say typically because the borrower may certainly pay the UFMIP as part of his or her settlement fees. But, when you think about it, most people who pursue FHA loans are lured to this product by its lower-than-standard minimum down payment. And, if that’s the case, chances are that the borrower is cash-strapped. And if that’s the case, chances are that he or she would not have the UFMIP to pay out of pocket at settlement. But, if he or she did and wanted to, he or she could certainly do so.
Unlike the formula to structure a conventional purchase money mortgage (purchase price minus down payment equals loan amount), structuring an FHA purchase involves an additional step. To structure an FHA purchase, the formula changes to, “purchase price minus down payment equals base loan amount.” The base loan amount is then multiplied by the standard 1.75% UFMIP factor and the result is the UFMIP. The UFMIP is then added to the base loan amount to establish the total loan amount which is then typically rounded down to the nearest $50. The only time when the UFMIP factor would not be 1.75% is when the mortgage application is for an FHA streamline refinance. In the case of an FHA streamline refinance, the UFMIP factor is reduced to 0.01%. In the event that a borrower refinances his or her FHA loan during his or her loan’s first few years, he or she could be entitled to a pro-rated refund of the UFMIP.
It is vitally important for the mortgage loan originator to be thoroughly familiar with MIP in order to best serve his or her FHA customers. And now you are!