When you buy a home with an FHA loan and you don’t have at least 20% to pay, mortgage lenders ask you to pay an FHA mortgage insurance premium, or MIP, which protects them from losses if you can’t. not repay the loan. .
FHA loans are attractive to some buyers because they come with lenient credit requirements, low closing costs, and competitive interest rates. The added expense of FHA mortgage insurance, however, is a major downside to this financing avenue.
What is FHA Mortgage Insurance (MIP)?
An FHA Mortgage Insurance Premium (MIP) is an additional fee you pay to protect the financial interests of the lender in the event that your FHA loan defaults. FHA borrowers are required to pay two mortgage insurance premiums: an upfront premium at closing and another annually for as long as you pay off the loan, in most cases.
In comparison, conventional loans with less than 20% down payment come with private mortgage insurance (PMI), billed annually until you have at least 20% of the equity in your home. This is different from FHA mortgage loan insurance, which does not have the same equity threshold.
You might also come across Mortgage Protection Insurance (MPI), which is not a requirement for an FHA loan or any other type of mortgage. MPI is similar to disability insurance or life insurance in that it pays your mortgage if you become disabled, lose your job, or die.
How Much Does FHA Mortgage Insurance Cost?
- FHA initial MIP: 1.75% of the loan amount
- FHA Annual PIM: 0.45% -1.05% of the loan amount each year, depending on the amount borrowed, the loan-to-value ratio (LTV) and the length of the loan
Initial mortgage insurance premiums can be, and often are, funded by the amount of the loan, says Peter Boomer, mortgage manager at PNC Bank. Annual premiums are included in the borrower’s monthly mortgage payment.
If you borrow $ 100,000 and factor the cost of the FHA Upfront MIP into your loan, your loan amount will increase to $ 101,750 (or an additional 1.75% of the loan amount).
Of course, this also increases your monthly payment. On a fixed rate FHA loan of $ 101,750 over 30 years at 4%, your monthly mortgage payment (excluding home insurance and property taxes) would be $ 485, compared to $ 477 without MIP financing.
Add in the annual premiums as well and your monthly payment will increase again, adding an additional $ 72 per month, bringing the total to $ 557. This assumes that you make a minimum deposit of 3.5%, in which case you will be charged an annual MIP rate of 0.85%.
How long will you pay FHA MIP?
Although the law has changed more than once on this issue, current guidelines state that borrowers who have put less than 10% on an FHA loan must pay FHA mortgage insurance until the end of the loan term. . However, if you deposit at least 10 percent, you can have the FHA MIP withdrawn after 11 years of payments.
“The length of time a borrower pays the monthly mortgage insurance premium varies depending on the original loan terms,” Boomer explains.
The PMI on a conventional loan, on the other hand, can usually be canceled once a homeowner has 20% of the equity in their home.
How to Get Rid of FHA Mortgage Insurance
Paying for FHA mortgage insurance for 11 years or more may seem like a drag, but the expense doesn’t have to go on forever.
Many borrowers use FHA loans as a stepping stone that can help them realize their dream of home ownership, says Gary Acosta, co-founder and CEO of the National Association of Hispanic Real Estate Professionals. From there, they take steps to improve their credit scores and gain more equity in their home so they can refinance their FHA loan to a conventional loan on better terms.
“The FHA is a great start-up loan, but at some point it may also be beneficial to refinance it for lower monthly payments, including none. [mortgage insurance premiums] or PMI, ”says Acosta.
It is also possible to get out of FHA mortgage insurance by paying off your mortgage, but this can require a significant amount of resources. Before you pay off your loan, be sure to weigh the financial pros and cons.
Cost of FHA MIP vs. PMI
The speed at which you can take out mortgage insurance is obviously very different between FHA loans and conventional loans, but cost is another key differentiator.
The amount you pay for the PMI may vary depending on your credit score and the amount of the down payment. For borrowers with excellent or very good credit, or FICO scores of 740 or higher, PMI payments may be lower. As described above, annual mortgage insurance premiums for FHA loans vary depending on the length and amount of the loan.
Is FHA Mortgage Insurance Tax Deductible?
The mortgage insurance deduction expired in 2017, but was reinstated at the end of 2019. For this reason, you may be able to itemize the FHA Upfront MIP for the 2020 tax year, as well as retroactively for 2018 and 2019 tax years. It’s best to speak with a tax professional, however, to make sure you maximize this deduction if you qualify.
Pros and Cons of FHA Mortgage Insurance
Here are some of the benefits of FHA MIP:
- Premiums are fixed – FHA mortgage insurance premiums do not fluctuate with credit rating.
- Easier to qualify – FHA mortgage insurance helps borrowers who might not otherwise qualify for a conventional loan. With the MIP, the FHA is able to absorb more risk and therefore grant loans to less creditworthy borrowers.
- Lower down payment – With insurance, borrowers with a credit score of 580 and above can deposit as little as 3.5% on an FHA loan. Those with scores between 500 and 579 can deposit as little as 10 percent.
Here are some of the disadvantages of FHA MIP:
- Adds to the overall cost of the loan – The initial and annual costs of FHA mortgage insurance increase both your total loan amount and the monthly payment.
- Difficult to get rid of – Generally, there are only a few ways to pay for FHA mortgage loan insurance – you can either refinance to a conventional loan or pay off your mortgage in full.
At the end of the line
It is understandable to be concerned about the high costs of FHA mortgage insurance. Spending an initial premium is already a tough pill to swallow, and paying additional premiums for years, if not decades, can really eat into your budget.
However, FHA mortgage insurance doesn’t have to be paid forever, depending on your down payment or if you refinance the loan in the future. Investing in a home now could be a smart move, and an FHA loan could be what you need to make it happen.
“First-time homebuyers who struggle to save for a down payment with a high debt-to-income ratio, such as college graduates with student loan debt, would find an FHA loan useful,” Acosta said.
With additional reporting from Holly Johnson.