I answered Danni's question below directly, but decided it might be helpful to share eith Trulia readers. I'm doing it in two parts due to the limit on characters per response:
Okay, letâ€™s start with some definitions first:
FHA = Federal Housing Administration, an agency that insures loans for banks (among LOTS of other things)
Fannie Mae or Freddie Mac â€“ Govâ€™t sponsored enterprises that buy loans from banks to replenish the money lent out by the bank
MI = Mortgage Insurance in general. This can be issued by a private company (just like car or life insurance), or by a Federal agency. Mortgage insurance reimburses the lender for some or all of the loan amount in the event of a loss such as foreclosure.
PMI = Mortgage Insurance issued by a private company (Private Mortgage Insurance). PMI covers 12% to 35% of the loan in the event of loss depending on the type of loan, risk, and type of property.
MIP = Mortgage Insurance Premium (Issued by FHA). MIP reimburses 100% of the loss on a loan if the loan was originated using FHA rules.
Hereâ€™s how it works:
If you take out a â€œconventionalâ€ loan (ie a loan not insured by the Govâ€™t such as FHA, VA, or US RDA), and if you have a single loan amount greater than 80% of the purchase price (or appraised value for a refinance), Fannie Mae and Freddie Mac require that the lender obtain PMI to cover possible losses.
PMI is usually â€œborrower paidâ€ in the form of a monthly payment added to the regular payment for a certain amount of timeâ€¦ usually until the payment schedule brings the loan amount down to 78% of the purchase price (or appraised value on a refinance using the value at the time the refinance was signed). In some cases PMI is â€œlender paidâ€ as a lump sum at closingâ€¦ usually through profits on a slightly higher rate.
PMI rates are determined by several factors such as borrowerâ€™s credit score, type of income documentation, type of property, LTV (percentage of the purchase price taken up by the loan), type of loan. The problem with PMI is that most of the foreclosures have PMI, and the PMI companies have suffered massive losses over the past year or two. In response the PMI companies have raised premiums, reduced coverage, and otherwise scaled back the amount of risk theyâ€™ll insure. The result is some loans that meet Fannie Mae and Freddie Mac guidelines canâ€™t be insured (such as 100% financing loans).
MIP rates are set by FHA and at present donâ€™t consider credit score. MIP is calculated as 1.5% of the loan amount added to closing costs PLUS 0.5% of the loan amount spread out over 12 months and added to the monthly payment. Over time MIP monthly payments decrease, and MIP usually drops off after 5 years or if the loan payment schedule reduces the balance to 78% of the appraised value when the loan was taken out.
Example for FHA using 3% down payment:
Loan amount: $100,000
MIP at Close: $ 1,500
Monthly MIP: $100,000 x 0.5% = $500 / 12 months = $41.67 per month
Example for PMI using 5% down payment:
Loan amount: $100,000
PMI at close: $0.00
Monthly PMI: $68.33 using 25% coverage
With FHA you will pay a lower monthly premium but a big chunk will be added to closing costs (optionally it can be rolled into the loan on a purchase or refinance).
With PMI youâ€™ll have no fee at closing but pay more per monthâ€¦ BUT the rate above is just a quoteâ€¦ it assumes a score of 720+, 30 year fixed rate, property in California, single family residence, primary residence, and â€œApprove/Eligibleâ€ findings from Fannie Maeâ€™s approval software (which is subject to verification by the underwriter). Hereâ€™s the link to the calculator I used if you want to play with the numbers yourself:
Use â€œMonthly/ZOMP!â€ for â€œPremium Typeâ€ and 25% coverage. If the rate quote comes back with a warning, the PMI company might not issue the insuranceâ€¦ requiring more money down.
With MIP through FHA youâ€™ll get the insurance for 3% down. Because lenders are tightening their guidelines â€“ especially for low down payment purchases, and because PMI companies are tightening their guidelines as wellâ€¦ many folks are switching to FHA insured loans just to get MI coverage for down payments of 10% or less.
Your lender should be able to provide side-by-side comparisons of an FHA insured loan versus a conventional loan with PMI.
Itâ€™s wise to ask questions like thisâ€¦ to be sure youâ€™re getting the lowest cost MI for your situation.