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The Federal Housing Authority (FHA) always requires mortgage insurance on their mortgage loans. Its official name is Mortgage Insurance Premium (MIP) and is charged to the borrower at closing in two parts. One is usually financed with the loan, although it can be paid in cash. Because it is paid in full at the closing, it never goes away as long as you have the loan. The other is paid with each monthly payment as an escrow amount, like monthly taxes and insurance, and can be dropped off.


  


Significance

FHA is known for its low down payment requirement and credit guidelines that are looser than conventional lending. This risk is offset by mortgage insurance and makes this program available for borrowers who find saving money for a down payment difficult. In the event a borrower defaults and the home is foreclosed, it offers lenders a way to recoup losses. MIP has made it possible for millions of people to be able to buy a home.


Time Frame

When FHA makes changes to its guidelines, they are not retroactive back to all loans. They only affect future loans. The decision to allow MIP to be dropped went into effect on Jan. 1, 2001, so for MIP to be dropped off, the loan must have been taken out after that date. It can be dropped when the loan is paid down to 78 percent of the sale price.

Equity

FHA will require that you have 22 percent equity in your home to drop the monthly MIP. The loan must be paid down to 78 percent of the original balance, but you can pay extra against your principal balance to help expedite this. FHA requires a full five years of monthly payments be paid, so monitor your prepayments. If your purchase price is $100,000, you must have a balance of $78,000 or less. As your balance descends to 78 percent, call or write your lender to alert them that you want the MIP to drop off. Check the next monthly statement to see if the payment has decreased. It if has not; contact them again.


Calculations

If your purchase price is $100,000, and you choose to use a minimum down payment, which is 3.5 percent for FHA, you will pay $3,500 as a down payment, and the base loan amount would be $96,500. On a 30-year term, tthe upfront MIP will be 2.25 percent, which is usually financed into the loan. This $2171.25 amount is added, making the new amount $98,671.25. This odd amount is usually rounded down, making the new loan $98,650. The excess $21.25 will be added to the closing cost and collected at closing. This calculation creates the loan amount. To find the monthly MIP, multiply $98,650 times .0055 to get the added MIP, which equals $542.58. Divide by 12 to get a monthly amount of $45.21. This amount is the monthly amount that is eligible to be dropped off when the loan reaches 78 percent. Your loan must be current at the time it reaches 78 percent and, for FHA, a five year payment history must be paid for your lender to drop off the monthly MIP amount.


Appraisals

Unlike conventional lending, FHA will not allow an appraisal to be done on your property for the purpose of dropping off the MIP. You may have enough inflationary equity in your home to refinance your mortgage to a conventional loan. If your loan is lower than 80 percent of the appraised value, you should investigate a conventional loan where no mortgage insurance would be required.