What Is MIP for Mortgage Insurance?

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Mortgage insurance premium (MIP) is the name that FHA (Federal Housing Authority) uses for its insurance program which insures each and every loan that is financed through FHA. A small percentage of each loan is financed in the loan for the purpose of insuring the loan to the lender in case the borrower defaults. The resulting foreclosure carries high losses for the lender but he will be reimbursed by filing a claim with the MIP.

Function

If it were not for FHA, many people would not own homes. In a world of mortgage lending where as much as 20 percent down payment is required, FHA has the lowest down payment requirement in the industry. Borrowers do not need perfect credit or 740 credit scores to be approved for FHA. Banks can continue to make FHA loans to young borrowers with low down payments because of the MIP insurance coverage. MIP makes FHA loans safer lending for banks.

History

Back in the 1930s, at the end of World War II and the Great Depression, the U.S. economy was flat. Banks made very few mortgage loans, and those that did, required 50 percent down payment. Housing sales and construction had all but stopped. Millions of people were out of work which resulted in many foreclosures. In 1934, President FD Roosevelt created the Federal Housing Authority (FHA) where all loans must be insured with MIP to cover lenders losses if the borrower defaulted. The banks had to be made to understand that a loan with a very low down payment did not need to be considered high risk if there was a way to recoup their losses if the borrower defaulted. This problem was resolved by FHA's insurance program. Homes were built and sold, mortgage loans were made, jobs were created and the economy improved.

Two types

FHA's MIP is charged in two ways. The up front MIP (UFMIP) is the biggest charge, and is calculated at 2.25 percent of the loan amount. Example: A loan amount of $100,000 X .0225=$2,250 which is added to the loan amount, making the new loan amount $102,250. This amount can be paid at the closing in cash, but is usually financed into the loan. The second type of MIP is the monthly add-on of .55 percent. This is calculated at $102,250 X .0055=$562.37 as a yearly cost, divide this by 12=$46.86 which is added to your monthly payment. This monthly add-on can be dropped off when the loan reaches 78 percent of the beginning loan amount.

Benefits

The biggest benefit of the MIP insurance program through FHA is that borrowers can get financing for a home with a low 3.5 percent down payment. Saving money for a down payment is one of the most difficult tasks in the lives of young growing families. Renting can very expensive, medical and insurance costs have increased, and the bills seem to pile up. FHA is the only loan available where the entire down payment can be a gift from a relative.

Warning

When many foreclosures occur, risk management strategies are implemented. FHA is taking a more cautious approach in mortgage lending. As a result, UFMIP (up front mortgage insurance premium) has increased to 2.25 percent of the loan amount. The down payment will remain at a minimum of 3.5 percent of the loan amount, and it can be a gift from a relative. FHA now requires a minimum credit score of 580 (however most lenders require a 640 score). Previously, the seller could contribute up to six percent of the loan amount for the buyers closing costs. This has now been decreased to 3 percent.

References

About the Author

Joey Campbell spent eight years in real estates sales and property management. She has been active in residential and commercial mortgage for the past 23 years in the Southeastern U.S. Campbell has attended hundreds of seminars, and has written and conducted workshops on subjects such as credit, debt excelleration and prequalifying for residential mortgages.

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