The costs of buying a home and acquiring a mortgage quickly add up. At closing, you'll be presented with a stack of loan paperwork to sign and a laundry list of settlement fees known as closing costs. If your loan involved less than 20 percent for the down payment, or it's backed by the Federal Housing Administration, you have mortgage insurance. The coverage helps protect lenders against default, and you can cover part of the cost by rolling it into your loan.
The government insures approved lenders, reimbursing their losses if you default on an FHA loan. It imposes risk-based mortgage insurance premiums -- of which your lender becomes the beneficiary -- to fund the FHA mortgage insurance reserves used to pay lender claims. The coverage enables lenders to make loans with a low down payment requirement of 3.5 percent and finance borrowers with credit challenges and higher debt loads. Government mortgage insurance differs from private mortgage insurance on conventional loans.
Mortgage Insurance Types
The FHA has two types of mortgage insurance premiums. You pay the up-front mortgage insurance premium in a lump sum at closing. This is the type you can finance into your loan amount if you don't have the cash to pay out-of-pocket. Then there's the annual mortgage insurance premium, which you pay in monthly installments until you pay off the loan. You can't pay the first year's premium or consecutive annual premiums at closing or roll this expense into your loan.
Financed Mortgage Insurance
You pay interest on the up-front mortgage insurance premium when you finance it. The premium can run several thousand dollars, and because FHA is intended for cash-strapped borrowers, rolling it into the loan is the most popular and convenient method of paying for it. As of mid-2013, the FHA charges 1.75 percent of the base loan amount for the premium. On a typical $200,000 base loan amount, the premium costs $3,500. Your loan balance after absorbing the up-front mortgage insurance premium is $203,500.
Out-of-Pocket Mortgage Insurance
Your first installment of the annual mortgage insurance premium is due and payable at closing. Escrow, a third-party company that handles the exchange of funds between you and the seller, prorates the installment. It calculates how much you need to pay based on the time of month you close. For example, suppose you close on June 10; you pay 20 days worth of mortgage insurance at closing. Based on a monthly mortgage insurance installment of $225, you owe $150 at closing.
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