June 28, 2021
Anyone shopping for a home loan — especially first-time homebuyers — has probably heard about the FHA mortgage insurance premium (MIP). Although this is an extra cost to the borrower, there are advantages to this mortgage insurance. One of the biggest is that lenders are willing to loan money since they are protected against default. The FHA makes homeownership possible for millions of borrowers who don't qualify for a conventional loan. That's because the FHA is insuring the loans, which makes lenders more willing to loan. Read on to discover the pros, cons, and history of FHA's mortgage insurance.
FHA Loan MIP Rules
The FHA has had different mortgage insurance rules over the years, and these rules are reviewed annually.
Before 2013, you could get the mortgage insurance removed once you had 20% equity. But that changed for loans issued after June 2013.
Currently, every FHA loan requires a mortgage insurance premium to begin with. How long it remains depends on your down payment.
- If you put down less than 10%, the insurance remains for the life of your loan.
- If you put down more than 10%, the insurance remains for 11 years.
Two Types of FHA Mortgage Insurance
Borrowers pay a one-time mortgage insurance payment when they first get their loan. After that, they have a monthly insurance fee. These two types of FHA mortgage insurance are:
1. FHA Up Front Mortgage Insurance Premium (UFMIP)
When you get an FHA loan, there is an upfront mortgage insurance premium of 1.75% of the loan amount. That can be rolled into the loan or paid at closing.
If you refinance within three years, you may be able to get a refund credit to reduce the upfront mortgage insurance premium.
2. FHA Monthly Insurance Premium (MIP)
To the upfront insurance of 1.75%, there's also an annual MIP based on the loan parameters. MIP can range from 0.45% up to 1.05%. Here's an example of MIP at 0.85% of the loan amount. That's split up into 12 monthly payments.
Here's an example:
FHA Loan MIP Rate
|Home sales price||$300,000|
|3.5% down payment||$10,500|
|Initial mortgage amount (30-year term)||$289,500|
|UFMIP 1.75% of the loan amount||$5,066|
|MIP 0.85% of the loan amount annually||$2,461|
In the example above, MIP added $205 per month to the mortgage payment. As your loan balance goes down each year, so does your MIP since it's based on the balance.
FHA MIP Rules Change
In the past, once there was 20% or more equity, a homeowner could get the MIP on an FHA loan removed. But after June 2013, that changed. Now the insurance remains for 11 years to the life of the loan, depending on the down payment amount.
Although borrowers weren't happy about this change, it has added stability and profitability to the FHA.
Is FHA mortgage insurance premium tax deductible?
The IRS has extended the deductibility of MIP for the 2020 tax year. This can change at any time, so it's essential to check with your tax advisor annually.
Your end-of-year statement from your lender will break out how much you paid for MIP. Give that statement to your accountant.
An FHA Mortgage May Be Your Best Option
Rather than focusing on the cost of MIP, it's essential to look at the big picture.
In many instances, the FHA's low-interest rates can make up for all or some of the MIP. That's especially true for borrowers with credit scores of less than 700. When comparing FHA loans to conventional loans, borrowers with lower scores receive much higher conventional loan rates. But the FHA offers low rates to borrowers even if their credit isn't perfect.
When it comes to conventional loans, your rate will be much higher with a credit score of less than 700. So, you can't only compare interest rates. You have to compare your loan payment, including the mortgage insurance, to see which is better. And you have to consider which loans you can qualify for.
FHA Mortgage Insurance Helps You Get a Loan
If your credit isn't good enough, you could be turned down for a conventional mortgage. In that case, would you prefer to hold off on getting a home and work on your credit? Or would it be better to get an FHA loan and hopefully build some equity.
When rates are higher, holding off might be the best choice. But when rates are at historic lows, most borrowers choose not to wait.
How to Use an FHA Mortgage to Your Advantage
Over the last several years, the housing market has been strong. Equity is building faster than ever. Many first-time homebuyers or buyers getting back into the market take advantage of the ability to get an FHA mortgage.
Then as their equity is building, they work on their credit. Once their score is 700 and above and they have 20% equity, they refinance into a conventional loan without MIP.
How to Get Rid of MIP on an FHA Loan
As mentioned above you can eliminate MIP after 11 years with a higher down payment. The only other way to eliminate mortgage insurance on an FHA loan is to refinance.
Your choices are:
- Conventional Loans: As you probably know, one of the best things about conventional loans is that they don't require PMI once you have 20% equity. If you haven't built up enough equity, but the rates are low, you could go ahead and refinance. Then once you have enough equity, ask the lender to remove your PMI.
- VA Loans: If you're a veteran or service member, there's no mortgage insurance even with 0% down. Both FHA and VA are government loans. Generally, they offer some of the lowest interest rates available. If you're eligible for a VA loan, that's the first place to check. Like FHA, they have less stringent credit guidelines.
As you can see, FHA's mortgage insurance premium helps people who never thought they'd be able to buy a home. Don't sell FHA loans short just because of the MIP — these are outstanding mortgages.
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