Document Systems, Inc. ("DSI") has noticed in the last couple of months that FHA loan programs have been one of the most selected loan programs by its customers. FHA loans appear to be replacing the once popular subprime and Alt-A loans. The purpose of this article is to describe the two methods that the DocMagic software employs to calculate the declining mortgage insurance premium.

Method 1: Underwriter's Shorthand Method

FHA loan programs added before September 20, 2007 use the so-called "Underwriter's Shorthand Method." This Method computes the Monthly Mortgage Insurance Premium (MIP) based on the following formula:

(([Outstanding Loan Amount] - [Upfront MIP]) * [MIP Factor]) / 12

For Loan Terms greater than 180 months, the MIP Factor is 0.005 and 0.0025 for terms less than or equal to 180.

The Monthly MIP amount is recomputed every 12 months.

With this method, the 78% threshold value in the payment schedule (which indicates when the mortgage insurance drops off or is no longer required) is computed based on the loan-to-value ratio as follows:

[Base Loan Amount] / [Lesser of Sales Price or Appraised Value]

The [Base Loan Amount] is the [Total Loan Amount] less the [Upfront MIP].

Method 2: Average Outstanding Balance Method

FHA loan programs added on or after September 20, 2007 will use the Average Outstanding Balance (AOB) Method. The AOB Method is defined by HUD and became effective on May 1, 1998. Unlike the Underwriter's Shorthand Method, this Method uses the outstanding balances for each amortization year and computes an average amount. The average balance is then multiplied by the Annual MIP Rate to determine the Annual MIP. If the MIP is financed, then the result is divided by (1 + Upfront MIP Factor) to determine the Annual Premium. The Monthly MIP is computed by dividing the Annual Premium by 12.

Average Outstanding Balance (AOB) = AVERAGE (Outstanding Loan Balance for Amortization Year)

Annual MIP = [AOB] * [Annual MIP Rate]

For Loan Terms greater than 180 months, the Annual MIP Rate is 0.005 and 0.0025 for terms less than or equal to 180.

Annual Premium = [Annual MIP] / [1 + Upfront MIP Factor]

Monthly MIP = [Annual Premium] / 12

The 78% threshold value in the payment schedule shows when the mortgage insurance drops off or is no longer required. This computation utilizes a secondary amortization schedule with the monthly payment computed using the Base Loan Amount ([Total Loan Amount] - [Upfront MIP]) to determine the percentage threshold value.

Even though the AOB Method became effective on May 1, 1998, many of DSI's customers had previously requested that DSI use the Underwriter's Shorthand Method as this Method enabled their underwriters to easily calculate the Monthly MIP. Thus, the Underwriter's Shorthand Method was the default for calculating monthly MIP and the threshold value. However, DSI has noticed that many of its customers who recently downloaded FHA loan programs are requesting the AOB Method. For this reason, DSI has decided that for FHA loan programs added on or after September 20, 2007, the Average Outstanding Balance (AOB) Method will be used. Those customers who added FHA loan programs before September 20 will continue to use the Underwriter's Shorthand Method. If these customers wish to convert from the Underwriter's Shorthand Method to the AOB Method, a request to DSI's Customer Service Department must be submitted.

Any customer wishing to change the manner of calculating the mortgage insurance premium from the Underwriter's Shorthand to the AOB method should contact Customer Service, at (800) 649-1362.