If you finance a home with a Federal Housing Administration insured mortgage, you pay for the insured part through a mortgage insurance premium -- MIP -- included in your upfront costs and monthly house payment. Financing with a FHA loan allows you to buy a home with a down payment as low as 3.5 percent. To protect against losses on high loan-to-value mortgages, the laws require the FHA to collect MIP.
Two Types of MIP
The FHA requires you to pay two different types of insurance premiums on your government insured home loan. The FHA funding fee or upfront MIP is a one-time cost that is paid when the mortgage closes. The upfront MIP is calculated on the loan amount after your down payment is subtracted from the cost of the home. The upfront premium can then be added to the starting loan balance. The annual MIP is paid each year and is divided by 12 and included in your monthly mortgage payment.
As of April 2012 and continuing into 2013, the upfront MIP was 1.75 percent of the net loan amount. For example, on a $150,000 home purchase, the 3.5 percent down payment leaves a loan amount of $144,750. Multiply this amount times 1.75 percent results in a premium of $2,533, which increases the actual loan amount to $147,283. Starting on April 1, 2013, the annual MIP rate is 1.35 percent, which would be $1,988 per year or $165.70 monthly.
If you have a FHA home loan that was processed before April 1, 2013, you can stop paying the annual MIP when the loan-to-value ratio on your home drops below 78 percent and you have been making payments on the loan for at least five years. Starting in April 2013, new FHA loans will require that the annual premium be paid for as long as you have the loan.
MIP vs. PMI
The term MIP applies to FHA home loans. Other types of mortgages may also require mortgage insurance, but on these loans you will have private mortgage insurance -- PMI. The rates for PMI vary by the amount of down payment and your credit score. If you plan to put more than 5 percent as a down payment, compare the costs of a FHA loan with other mortgage options. You may be able to get significant savings on your monthly payment by going with PMI instead of the FHA's MIP.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.