FHA Mortgage Insurance Premium

FHA home loans are just that because you pay an FHA Mortgage Insurance Premium (MIP) to the Federal Housing Authority to insure the lender against loses they would take in the event that you defaulted on your promise to pay the loan back as dictated in the promissory note.

As of October 4th, 2010 changes are taken place regarding the FHA mortgage insurance premium and it will affect your monthly payment.

First lets start with a little education. If it were not for private mortgage insurance, VA or FHA, all traditional type of loans would require a minimum down payment of 20%. There are essentially four criteria a lender will look at in order to make a decision on whether or not to loan you money.

1. Your ability to pay – This is why they check your income sources and the likelihood of a continued stream of income.
2. Your willingness to pay – This is why they check your credit, to see if you pay your obligation on time and as agreed.
3. The collateral – This is why a lender will request an appraisal and in some cases an external home inspection. They want to ensure that they are basing their loan amount on the proper true value of the property.
4. The risk – How much risk do you burden and now much risk does the lender carry. This is where the down payment comes into play.

Let’s discuss the risk factor. The assumption is that the more “skin you have in the game” or, the more of your own money that is tied up in this property the more likely you are to do whatever it takes to make the payment so that the lender does not foreclose on the property.

This makes sense. Its one thing to have your life and all your belongings tied up in the house you live in but you add a whole new element if you have put $40,000 of your own money into the purchase of the home.

This is also why down payment requirements and interest rates are much higher for investment properties. If you were to lose your income and were faced with a decision, make my home payment or make my renters house payment it would probably take you a nanosecond to come to the right decision.

Not too long ago a 50% down payment was the going rate. With a strong US economy lenders slowly gravitated to a 20% down payment requirement. Simply put, lenders were comfortable knowing you would do whatever you needed to do to save your house and money.

However, the US Government has a strong initiative to prop up the housing industry and encourage home ownership. On top of that, simple statistics came into play and smart entrepreneurs put the numbers together to come up with yet another profitable insurance opportunity.

They figured, by spreading the risk among many, they could cover the down payment requirements, take the hit on the few, and make a nice profit.

Of course, the insurance companies did not want to have to come up with the 20% down payment, they would rather continue to have their money working and earning interest. The proposal was simple; if the lenders were willing to loan up to 95% the insurance company would cover the 15% if the lender were forced to repo the home (foreclosure).

This seemed like a win-win for the lenders, they could surely sell the home quickly at 80% of its value to remove it from the books. The insurance companies would win knowing that the foreclosure rate would be somewhere around 3%, the many would cover the few through monthly premiums.

And thus, Private Mortgage Insurance was born (PMI).

That is a very simple overview of how it works. If you were to apply for a traditional home loan (conventional financing) and put only 5% down you would be required to pay PMI to cover the lenders risk.

Because this is private the rates vary but you could expect to pay.85% annually of the loan amount prorated monthly. For example; on a $200,000 loan you would add about $141 to your monthly payment.

The more money you put down the lower this monthly rate would be. And, if your property appreciated in value, coupled with loan principal reduction, you could ask the premium to be lowered (of course you would have to pay for an appraisal to lower this monthly payment slightly, not worth it most of the time).

When using conventional financing there is no upfront payment only monthly.

Now, seeing this business model as one that would work, the Government saw a great opportunity to jump in and spring the home ownership initiative in fast forward.

So essentially, FHA home loans were born. They work in the much of the same manner as the private sector.

There are two major exceptions:

1. Because FHA is taking most of the risk they get to dictate the guidelines in which a borrower can be approved.
2. FHA charges an Up Front premium as well as a monthly premium. AND, the upfront portion can be financed into the loan amount.

So here is the skinny. In my opinion FHA home loans are the absolute best option for most first time home buyers. But it comes with a price (as all loans do).

As of October 4th, 2010 to borrow money from a lender insured by the FHA you will be required to pay…

A 1% Up Front mortgage insurance premium that can be added to the loan amount.

.9% or 90 basis points annually prorated for a monthly premium.

Example: The home you want to make an offer on has been negotiated to cost you $200,000. You are using FHA so you can keep your down payment requirement to the low 3.5% (10% if your credit score is between 500 – 570. Good luck getting any conventional financing with those scores).

* Down Payment – $7,000
* Loan Amount – $193,000
* Upfront MIP – $1,930
* New Loan Amount – $194,930
* Annual MIP – $1,754.37
* Prorated monthly – $146.20

The figure above that is most important to you is the $146.20 added to your payment each month. So when qualifying for a loan this must be added but you cannot add it until you know the loan amount (the chicken or the egg).

Yes, mortgage insurance can be expensive and is more expensive with FHA financing but look at the trade-offs. The big one is your low down payment requirement with FHA home loans. This allows you to keep more money in your pocket to help with moving expenses, furnishings or better yet, letting that money continue to earn interest.

Condo, Coop and HOA Master Insurance Premium

I’m sure that a lot of condo/coop & HOA board members have the following question: how come on my Automobile & HO-6 Insurance policies I pay the premiums directly to the insurance carrier, and I have the option of monthly installments, whereas on the condo/coop or HOA master insurance policy I have to pay the premiums to my agent or broker, and the premium has to be paid in full upon binding of the policy and if I can’t afford to pay it in full then we have to get premium financing? That’s a very good question, and it all comes down to 2 main ways that insurance premiums are being charged:

  1. Direct Bill
  2. Agency Bill

Direct Bill

Most personal lines insurance policies, including personal automobile insurance, homeowners insurance, renter’s insurance and personal umbrella insurance are direct bill. This means that the insurance carrier is billing the policy holder directly. Most personal lines insurance policies come with the option of quarterly or monthly installments, you’ll have to pay a down payment (usually 20%) upon binding, and the rest will be split up to quarterly or monthly installments. In most cases you’ll be charged a small fee for every installment anywhere from $1 to $6 depending if you set up automatic withdrawals from your bank account. Once the policy is in effect, the agent or broker has nothing to do with the billing of your insurance policy (of course he’ll get a notice of cancellation if you don’t pay your premium and call you up to make sure that you’ll make a payment so your policy shouldn’t cancel). This is why on all your personal insurance policies you pay the insurance company directly and you have the options of installments.

Agency Bill

But when it comes to your condo/coop or HOA’s master insurance policy it’s a whole different story. Most condo/coop or HOA policies are agency billed, this means that the insurance carrier is billing the insurance broker the full policy premium, and the broker has to bill the condo/coop or HOA association. The broker usually has 30 to 90 days to pay the full premium to the insurance carrier. This is the reason why you pay the insurance premiums to the insurance agent or broker and why it has to be paid in full. But what if your condo/coop or HOA association can’t afford to pay the whole premium at once?

Premium Financing

Most condo/coop or HOA associations don’t have extra money lying around, so when your policy premium is more than $20,000 it’s kind of hard to pay the full amount up front, that’s when premium financing comes in to play. Your insurance broker should help you out with the premium financing; there are a lot of good financing companies out there. The interest rates are usually between 6 & 10%. They will only finance about 80% of the premium, which means that you’ll have to pay about 20% upon closing. How does the whole financing process work? The financing company sends a check of the full premium (minus your 20% down payment) to the insurance broker. Then the insurance broker sends to the insurance company the down payment that he got from the condo/coop or HOA and the check that he got from the financing company (minus his commissions). Then the financing company is going to bill you monthly or quarterly with a 6 to 10% interest rate. The following is something that unfortunately happens quite often: The insured made sure to have the policy paid up in full, whether by paying the full amount or by getting premium financing, and after a few weeks they get a notice of cancellation in the mail. What happened here? Very simple, your broker received the full amount, now he has up to 60 days to pay the company, and very often brokers neglect or on purposely delay paying the insurance company right away. This is wrong and illegal and you should stay away from such insurance brokers.

Benefits and Risks of Life Insurance Premium Finance

Life Insurance Premium finance is the safer way of purchasing life insurance, especially for high net worth individuals. It allows a company to borrow the cost of life insurance premiums. It usually occurs when the company has a very high premium that makes it necessary to borrow the amount in part or in whole to prevent reducing the company’s liquidity.

More often than not, traditional lenders don’t provide premium financing, and business owners need to look for specific premium financing providers to secure the loan.

Benefits of Premium Finance

When a company releases a large amount of payment, its owner must first consider whether the funds are needed for the daily operation of the company or for the expansion of the business. And in order to prevent liquidating some of the company’s assets or using key funds, financing is required.

More often than not, businesses depend on some type of loan to be sustainable. Premium financing is often a part of the debt cycle for company with high corporate owned life insurance costs.

A business owner can finance multiple policies via a single agreement that allows the owner to make a single insurance premium payment a month. In most cases, insurance companies accept premium financing and accept payment straight from the finance provider. When that is the case, the premium finance company will bill the business owner instead of the insurer.

Premium Financing of Non-Qualified Executive Bonus Plans

Premium financing can be used on non-qualified executive bonus plans, which are available for vital employees of any type of corporation. The employer has the discretion to select the workers to cover and the amount of the bonus. The business owner pays for the premiums on the policy, and the employee has to pay tax that’s equal to the premium amount.

Financing of 770 Accounts

A 770 account is a permanent life insurance policy that has been structured to maximize its cash value. By maximizing the total death benefit and cash value, you can maximize the cash value of the life insurance policy. More often than not, the cash value is tax-free and can be accessed at anytime.

770 accounts have a very competitive rate of return and can be used as collateral. But the premiums can be high. High net individuals or business owners can resort to financing in order to keep up with the premium payments without the need to liquefy assets.

As you can see, financing life insurance premiums can help individuals and companies that need to pay large amounts of premium. It allows them to stay liquid while providing insurance coverage to oneself or one’s employees. This is ideal for corporate owned life insurance programs as well as private banked owned life insurance policies.