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The Federal Housing Authority (FHA) is a lender backed by the government. The government created the program to help increase home ownership in the United States. The mortgage insurance provided by FHA is for the borrower who does not have the down payment requirements most lenders want. If the borrower has less than 20% down then FHA might be a choice for their mortgage loan. The FHA, as a rule, has the lowest down payment requirements of most lenders in the industry.

The mortgage insurance is paid for by the borrower but it benefits the lender. If the borrower can no longer make mortgage payments due to unemployment, death, or disability and the property goes into the foreclosure process, the mortgage insurance will help insure some of the loss the lender may incur. The mortgage insurance helps absorb some of the risk the lender takes. Therefore the lender can offer a loan to a borrower that other lenders will not approve. Let’s look at the cost of the Mortgage Insurance Premium (MIP) first.

The cost of the MIP is calculated based on the length of time for mortgage repayment. For a 30 year mortgage the rate is 1.75% of the entire mortgage amount. Monthly amounts are figured at .55% of the total amount of the loan. The .55% is an added amount above the 1.75% up front fee paid at loan closing. Let’s use $100,000 as an example of your total loan amount. You will need to convert the percentage into a decimal. To do so you simply move the period to the left two places or you divide 1.75/.0175. $100,000 X .0175 = $1,750. This is your up front mortgage insurance premium fee.

To determine the monthly add on premium you need to divide the total amount of your loan by .55%. Using the $100,000 amount of your loan: $100,000 X .0055 = $550. This is considered to be the annual rate. To find the monthly add-on you will divide by 12. $550/12 = $45.83. You will be responsible for paying this premium until you meet the lender’s requirements for dropping the insurance. You will be eligible, with good credit history, when you owe around 78% on your loan.

Now we need to calculate the amount is you have a 15 year mortgage. This length of mortgage has different conditions. The most important to you is that there is no add-on monthly insurance premium. Your up front percentage may be higher or lower, depending on the rules.

If you are a senior citizen and you are applying for a reverse mortgage, you will pay a fee of 2% of the total value of the home. This is considered an upfront fee. The reverse mortgage is a loan to the senior that will be paid out in monthly payments until the senior dies. If the senior lives longer than the anticipate length of time, the lender would lose money. This is where the mortgage insurance helps to mitigate the risk to the lender. When the insurer pays on the claim the insurer will pay the lesser of the sales price of the home or the balance left on the note.

This reverse mortgage is attractive to lenders because the FHA backs the note with mortgage insurance. You qualify for the loan if you are older than age 62 and you have equity in your home. You can apply for a lump sum payment or you can have the lender mail you monthly installments. The loan will be approved based on the equity and/or value of the property. Your credit history is not a factor, nor do the regular credit eligibility requirements apply. You must live in the property to be accepted for a reverse mortgage. If you move or you pass away, the loan must be paid in full. The home will be sold to satisfy the balance on the note. If the home is passed to another by inheritance then the heir can redeem the home by selling it or paying off the note. If the home is sold the profit of the sale would belong to the heir. If the home is sold for a loss due to decrease in value or other factors, then the FHA MIP will pay the lender the difference. Note: The senior who relocates or the heir who inherits is only responsible for the amount of the home that is market value or the balance of the note whichever is smaller.

The risk of loss to the lender is negligible. A lot of lenders who initiate a loan will sell the loan after a period of time. FHA loans have a high resell value on the Wall Street market. This means that the lender can sell the loan, take the proceeds and have even more capital for lending to other borrowers. The lender is not the only one who benefits from FHA loans.

The home owner who is young or doesn’t have the savings for a down payment is also reaping the benefits of the FHA program. If the borrower is trying to get a conventional loan he/she will often have to put down at least 20% and have a high credit score for an interest rate that would make the payment affordable. With the FHA loan there are no requirements for a large down payment, the credit score can be less that the 720 other lenders require, and there are no restrictions to MIP. Is some areas where there have been a large amount of foreclosures, insurers may not offer PMI. With FHA the borrower can have a higher debt to income ratio and the down payment percentage is 3.5%.

As you can see, the FHA loan benefits a lot of people. This agency that was created in 1934 was formed to provide a way for borrowers to purchase homes that were foreclosed during the Great Depression. Because the mortgage insurance reduced the risk to lenders, the program worked and the industry responded as expected.