Borrowers who have difficulty qualifying a conventional home loan can get financing by paying mortgage insurance. The Federal Housing Administration expands home ownership opportunities to moderate-income borrowers with some credit challenges and minimal funds for a down payment. The FHA charges one-time and recurring mortgage insurance premiums to build reserves used to pay lender claims should a consumer default on the loan. Borrowers can choose how to pay the premium.
The FHA charges two types of mortgage insurance premiums: an upfront mortgage insurance premium, or UFMIP, and a monthly mortgage insurance premium. The FHA lender collects the monthly premium together with the mortgage payment and charges the UFMIP as a lump sum at closing. Borrowers have the option of paying the UFMIP in cash, along with other closing costs.
You can prepay the UFMIP in a lump sum at closing just like daily mortgage interest and the homeowner's insurance premium. However, you also may pay it over the life of the loan by adding it to the loan's principal balance. For example, on a $180,000 loan, the FHA charges 1.75 percent of the base amount for the UFMIP, as of 2013. Should you finance the $3,150 premium, your new loan amount will be $183,150, which you can pay over the life of the loan.
Although prepaying the UFMIP at closing has its advantages, most FHA borrowers finance the fee to keep closing costs as low as possible. When prepaying the UFMIP, you must prove, prior to closing, that you have enough money to cover it, plus the down payment and the rest of your closing costs. Financing the UFMIP helps you qualify with limited reserves.
The UFMIP and the annual mortgage insurance premium are two distinct FHA costs. The main difference, however, is that your annual mortgage insurance premium may be dropped over time. As you pay down your loan, your home equity increases. So, paying your mortgage on-time for at least five years and building at least 22 percent equity leads to automatic cancellation of the annual mortgage insurance premium.