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An FHA loan is an FHA loan because it follows the rules and guidelines of the Federal Housing Administration (FHA). This loan is written by an FHA approved lender, and after closing, gets insured by the FHA. As long as the lender has followed FHA guidelines, this insurance allows them to be free of any potential losses on that loan due to foreclosure etc.
Upfront Mortgage Insurance Premium (UFMIP) is a fee that is charged on every FHA loan that is written. This is essentially the ‘insurance fee’ paid to directly to FHA to insure the mortgage. The way FHA insures loans is by collecting this UFMIP, as well as a monthly insurance premium, and moving those funds into a pool. Any time someone defaults on an FHA loan, the FHA is able to dip into that pool to satisfy the mortgage and keep the bank from losing money.
In addition, the use of the UFMIP, which can be and usually is financed, allows for a lower monthly MIP. This rate on the monthly MIP is often much lower than conventional Private Mortgage Insurance. Even with the financed UFMIP, the total payment is usually lower. The UFMIP has had a varied history. At one point in the early 90s, it was 3.8% of the loan amount and there WAS not a monthly MIP. There have been several formula changes in the past 15 years and another one will be put into place next year.
It is always good to show your borrower a side-by-side comparison of closing costs, pre-paid expenses and total monthly payment using FHA, Conventional and any other commonly used program.
What is the best way to describe to a borrower what “upfront mortgage insurance premium” is and why it is charged with an FHA mortgage?