FHA MIP, UFMIP (Mortgage Insurance) Explained
In order for HUD to insure FHA Mortgages on a National level - they need to allocate money into a General Insurance Fund. Of course this fund is invested in several A Rated Bonds and other secure investments, the money is for the most part liquid in order to pay lenders money on defaulted FHA loans. Of course this money comes from HUD directly, it is not their money inevitably - its yours!
When an FHA loan is initially taken out - there is a "Fee" known as UFMIP (Up Front Mortgage Insurance Premium). This "UFMIP" is 1.75% of the initial loan amount. Unfortunately, this money is added to the initial loan amount and is "financed" over either 15 or 30 years. Your payment is then calculated based on the "increased" loan amount - (Initial Loan Amount + UFMIP). This Up Front fee is what directly goes into the aggregate insurance fund held by HUD to pay out on those defaulted loans nationally.
That's not the only fee however. HUD also collects a monthly insurance premium referred to as MI or Mortgage Insurance, and depending on the LTV (Loan to Value) can range from .50% to .55% (in cases over 90.01% LTV) The way it works is simple. You take the loan amount and multiply it by the correct MI rate and that yields a number. That number is then divided into 12 monthly installment payments (which equals your Monthly Insurance Premium or MI).
Traditionally, Mortgage Insurance is applicable to anything over 80% LTV however FHA Loans require the Mortgage Insurance for a minimum of 60 months (5 Years). Ultimately, the cut off for the MI is 78% LTV however if 78% LTV is attained prior to 60 months, the insurance is still applicable. This monthly premium also gets paid directly to HUD from the lenders that collect the premium and these funds are also allocated into the General Insurance Fund for HUD.
One more thing to know about the UFMIP. Should you refinance within the first 60 months - the initial 1.75% fee is divided by 60 months, just like the monthly MI and if you were to refinance into a "New" FHA loan from your previous one - the 1.75% fee gets Pro-Rated and a refund will be generated for the "Unused" portion of that initial fee. Although doing a new FHA loan will require a new 1.75% fee to be charged, some of the cost will be offset by the refund received from the unused portion of the previous UFMIP.