Prospective and current homeowners have several options when it comes to financing a home purchase. From conventional home loans to special financing programs, mortgage solutions exist for nearly every kind of buyer. One of the more common mortgage programs is an FHA loan, designed to meet the needs of borrowers with a small down payment to contribute.
Although FHA home loans can be beneficial in affording some buyers the ability to purchase a home with a lower out-of-pocket expense, they come with a few disadvantages. The most substantial caveat to an FHA mortgage is required mortgage insurance.
What is FHA Mortgage Insurance Premium (MIP)?
The Federal Housing Administration is a government agency providing lenders the ability to offer insured mortgage loans to certain borrowers. FHA home loans were initially designed for individuals with low-to-moderate income, and those who had lower credit scores.
However, in recent years, FHA mortgages have become more popular among borrowers who want to bring less of a down payment to the table. This is because FHA-backed home loans can be granted for up to 96.5% of the total value of the home, meaning a down payment of just 3.5% is required.
Although the FHA mortgage program gives many potential home buyers distinct benefits, mortgage insurance is necessary as part of the deal. An FHA mortgage insurance premium, known as MIP, is a safeguard put in place because of the low down payment required on FHA-backed loans. Lenders want to feel confident that, in the case of borrower default, they are not on the hook for a substantial portion of the remaining mortgage balance.
FHA MIP is a combination of an up-front insurance premium and an ongoing monthly payment, based on the size of the loan and the amount of the initial down payment. For some borrowers, FHA mortgage insurance premiums remain in place for the life of the loan; others pay for a set number of years. Here’s how the cost of MIP breaks down.
The Cost of FHA Mortgage Insurance Premium
The initial cost of FHA MIP is 1.75% of the total mortgage amount. The up-front premium is rolled into the home loan for most borrowers, adding to the total cost of borrowing from the start. The ongoing cost of MIP, however, can be far more expensive over the long term. The annual MIP for FHA mortgages, which is broken up on a monthly basis, is calculated as follows:
a. Cost of MIP for 15+ Year Mortgages Less Than $626K
For mortgages longer than 15 years and a loan amount of $625,000 or less, borrowers pay .80% of the loan amount per year. This applies if the down payment is 5% or more. Borrowers who contribute 10% as a down payment pay MIP for 11 years, while those who provide between 5 and 10% pay this premium for the life of the loan. Homeowners who put down less than 5% pay .85% of the loan amount, for the life of the loan.
b. Cost of MIP on Loans Above $625K
For loans above $625,000, borrowers who make a down payment of 10% pay 1.00% in MIP for 11 years. Those who provide a down payment between 5 and 10% pay the same 1.00% premium, but for the life of the loan. Down payments that are less than 5% require a homeowner to pay 1.05% MIP for the full term of the mortgage.
c. Cost of MIP on 15 or Fewer Year Loans
Different terms apply for those who use an FHA loan with a low down payment for a mortgage with a 15-year repayment term. Mortgage insurance premiums for those who bring 10% to the table are .45%, payable for 11 years. Borrowers who have a lower down payment pay .70% for the life of the loan.
How to Cancel MIP on FHA Loans
Before the FHA MIP rate reduction that took place in 2015, borrowers could either request the insurance be canceled or it would automatically be dropped when the loan-to-value of the home reached 78%. Now, unfortunately, mortgage insurance premiums do not end that easily. Instead, homeowners have only a few options for canceling MIP on FHA loans.
1. Wait Out the Term to Get Rid of MIP
Based on the amount of a down payment you provided, the amount of the loan, and the original loan repayment term, FHA MIP is due every month for either 11 years or the life of the loan. If you fall into the first category, you can contact your lender once you hit the 11-year mark and request MIP be dropped. Unfortunately, if you fall into the latter group of borrowers, you’ll need to focus on alternatives.
2. Pay Extra on Your Monthly Payment
One way to get rid of FHA MIP faster is to pay extra each month toward your home loan. Paying an additional amount toward the principal balance each month, or periodically throughout the year, will expedite the repayment period, sometimes substantially. While this method does not allow you to request cancelation of FHA MIP, it does mean you are eliminating your total mortgage obligation faster.
3. Refinance to a Conventional Loan
Most homeowners who are tired of FHA mortgage insurance premiums opt to refinance into another home loan. Getting out of an FHA mortgage by taking on a new conventional mortgage is one surefire way to stop paying the premiums required by FHA lenders.
Refinancing comes with its own costs, however. Closing costs may be necessary, and you may ultimately reset the total repayment term of the loan.
Fortunately, refinancing may also give you the opportunity to lock in a lower interest rate, reduce your mortgage term, or both. This can be a powerful cost-saving strategy when combined with the benefit of eliminating MIP requirements.
Final Thoughts on Canceling FHA Mortgage Insurance Premiums
Canceling FHA mortgage insurance premiums is a great way to save up to hundreds of dollars each month. However, doing so is not a simple task for everyone. Luckily, many borrowers who took out an FHA home loan prior to June 2013 will still benefit from automatic cancellation.
Furthermore, if you bought your home before June 2013 and have at least 22% equity in your home, and all mortgage payments have been made on time, you are eligible to request cancelation of your MIP after five years.
For all other homeowners, refinancing your home mortgage is typically the best solution to eliminate FHA mortgage insurance premiums.
