FHA Mortgage Insurance - What's all the fuss?

In the last post we discussed Mortgage Insurance - what it is and why it is needed?  We dealt specifically with the conventional loan requirements on Mortgage Insurance and hinted at FHA - the Federal Home Administration program.

How do they differ? 

• FHA - requires a two step process with Mortgage Insurance. 

• They have an Upfront Mortgage Insurance payment that is equal to 1.75% of the base loan amount.  This mortgage insurance can be added back to the loan amount so it isn't a cost out of the borrowers "immediate" pocket.  However, it changes the LTV on the loan from 96.5% to 98.25% - essentially leaving the borrower with very little equity.

• The 2nd part is the monthly MI.  Currently at 1.35% of the loan amount.  This is a monthly figure and is paid out every month to FHA for the use of the program.  Changes in June of 2013, which you can read on the Mortgagee Letter 2013-04 - HUD, state that the Mortgage Insurance will never be removed from the mortgage except by way of refinance to a conventional program or paying off the loan.

• Conventional - this allows for either an Upfront Mortgage Insurance amount to be paid 1x (cannot be financed in most cases - though it can be in some) or the monthly MI.  The monthly MI still automatically falls off when the borrower reaches the 78% threshold in LTV.  Fannie Mae requires the monthly be kept for a minimum of 2 years but after that the borrower could request that it be removed.

How does this impact the borrower?  - The long term borrowing costs for the FHA deal are quite a bit higher than the Conventional program now that the MIP is up to 1.35% for all FHA deals (with the minimum down payment) and that the MIP will never go away. 

FHA is still a viable option for first time home buyers, borrowers that are 3 years from a foreclosure, and for borrowers with limited asset resources.  However, if the borrower can use conventional financing, both short term and the long term advantages are beneficial.  (i.e. more equity in the property, less borrowing costs, and flexibility with removing the MI - which will save thousands in the long run.)