FHA Loans Offer Benefits, But New MIP Cancellation Policy is Costly

FHA loans offer several key benefits to borrowers. The biggest advantage, and thus the biggest lure, is the 3.5% down payment option. Borrowers with credit scores above 580 who meet all other program requirements can put down as little as 3.5% of the purchase price, when using an FHA loan. These mortgages are typically easier to obtain as well, when compared to conventional (non-government-backed) mortgages.

But borrowers are paying a higher price for the ‘privilege’ of using an FHA loan. Future changes announced by the Department of Housing and Urban Development (HUD) will increase those costs even more. Here’s an update on the latest policy changes.

New Rules for Cancellation of FHA MIP

HUD has made numerous changes to the FHA loan program in recent months. Among other things, they have increased insurance premiums and implemented new rules for credit scores and debt ratios.

Another, more significant, change will take effect in June 2013. It pertains to the cancellation of the annual mortgage insurance premium charged on all government-insured loans.

Borrowers who use an FHA loan to buy a home must pay for two different types of insurance. There is an upfront mortgage insurance premium (MIP) that equals 1.75% of the loan amount, as well as an annual MIP that is typically paid 12 times per year as part of the monthly mortgage payment.

Currently, borrowers are able to cancel their annual MIP once their loan-to-value (LTV) ratio falls to 78% or less. But this will soon change. After June 3, 2013, some borrowers will have to pay their annual premium for the life of the loan — or up to 30 years.

Here’s an overview of the original policy and the changes that will take effect in June 2013.

Original Policy
The original policy regarding the cancellation of MIP was introduced in 2000. HUD Mortgagee Letter 2000-46, released on December 20, 2000, states the following: “FHA’s annual mortgage insurance premium will automatically be canceled-once the unpaid principal balance, excluding the upfront MIP, reaches 78 percent of the lower of the initial sales price or appraised value…”

Revised Policy
The new rules for cancelling the annual MIP are outlined in HUD Mortgagee Letter 2013-04, which was released on January 31, 2013. That policy letter states: “For any mortgage … with an LTV greater than 90%, FHA will assess the annual MIP until the end of the mortgage term or for the first 30 years of the term, whichever occurs first.” Loans with an LTV less than or equal to 90% must carry mortgage insurance until the end of the term, or for the first 11 years of the term, whichever occurs first.

* Title I home improvements loans and Home Equity Conversion Mortgages (HECM) are exempt from the new rules, and therefore will not be affected by them.

The table below shows the relationship between loan term, LTV, and the earliest opportunity for cancellation of MIP:

FHA MIP cancellation rules

Agency Reacting to Claims-Related Losses

The Federal Housing Administration is a governmental insurer. They provide insurance to approved mortgage lenders that protects them from losses resulting from borrower default. When insurers suffer major financial losses resulting from an unusually high volume of claims, they change their policies to protect themselves from further losses. This is precisely what the FHA is doing.

The agency has suffered tremendous financial losses over the last few years, resulting from a tidal wave of bad mortgages and the resulting insurance claims from lenders. Historically, the FHA has been a self-sustaining agency with no need for tax dollars. In the past, they’ve been able to cover their losses (claims) from the funds generated by insurance premiums. But the housing crisis changed all of that. It created a scenario where there were too many claims in too short a period of time.

Today, there is even talk of a bailout. According to Jeb Hensarling, chairman of the House Financial Services Committee: “We now know for certain that the FHA is not just broke, the FHA is bailout broke.”

Others argue that the agency is not that bad off. In a recent article for U.S. News & World Report, Jason Gold of the Progressive Policy Institute said that “recent estimates suggest the agency’s balance sheet doesn’t look nearly as bad as many analysts expected.”

But most agree the Federal Housing Administration’s current model is unsustainable. Hence the changes we are seeing. The new policy regarding the cancellation of MIP is yet another reminder of the agency’s desperate financial situation, and its need to shield itself from further losses.

As mentioned earlier, HUD also increased the annual MIP rates charged on most FHA loans. This change took effect last month. Here are the revised rates for loans with case numbers assigned after April 1, 20113.

Loan Term more than 15 Yrs
Base Loan Amount $625,500 or less Base Loan Amount above $625,500
LTV 95.01% or more 1.35%
LTV 95.00% or less 1.30%
LTV 95.01% or more = 1.55%
LTV 95.00% or less = 1.50%
Loan Term 15 Yrs or less
Base Loan Amount $625,500 or less Base Loan Amount above $625,500
LTV 90.01% or more = .70%
LTV 78.01% to 90.00 % = .45%
LTV 78.00% or less = 0.00%
LTV 90.01% or more = .95%
LTV 78.01% to 90.00 % = .70%
LTV 78.00% or less = 0.00%

Note: The percentages shown above apply to the amount being borrowed. For instance, a 1.5% annual premium on a $200,000 loan would come to $3,000. That’s what the borrower would pay each year for the added cost of mortgage insurance.

If you’re planning to use an FHA loan to buy a home, you might want to do it sooner rather than latter. There is still time to avoid the added costs associated with the new MIP cancellation policy. Loans with a case number assigned before June 3, 2013 will not be affected by the change.