FHA Mortgage Insurance coverage: Why It's Mandatory And So Costly – Bankrate.com

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When you buy a home with an FHA loan and don’t have at least 20 percent to put down, mortgage lenders require you to pay an FHA mortgage insurance premium, or MIP, which protects them from loss if you can’t 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 key drawback to this avenue of financing.
An FHA mortgage insurance premium (MIP) is an additional fee you pay to protect the lender’s financial interests in case you default on your FHA loan. FHA borrowers are required to pay two mortgage insurance premiums: one upfront at closing, and another annually for as long as you repay the loan, in most cases.
By comparison, conventional loans with less than 20 percent down come with private mortgage insurance (PMI), charged every year until you have at least 20 percent equity in your home. This is different from FHA mortgage insurance, which doesn’t have the same equity cutoff.
You might also encounter mortgage protection insurance (MPI), which is not a requirement for an FHA loan or any other kind of mortgage. MPI is similar to disability or life insurance in that it pays your mortgage if you become disabled, lose your job or pass away.
Upfront mortgage insurance premiums can be, and often are, financed into the loan amount, explains Peter Boomer, a mortgage executive with PNC Bank. Annual premiums are included in the borrower’s monthly mortgage payment.
If you borrow $100,000 and roll the cost of FHA upfront MIP into your loan, your loan amount will increase to $101,750 (an additional 1.75 percent of the loan amount). Naturally, that increases your monthly payment, as well. On a $101,750 30-year fixed-rate FHA loan at 4 percent, your monthly mortgage payment (excluding homeowners insurance and property taxes) would be $485, compared to $477 without financing the MIP.
Tack on the annual premiums, too, and your monthly payment will rise further, adding another $72 per month, bringing the total to $557. That’s assuming you make a minimum down payment of 3.5 percent, in which case you’ll be charged an annual MIP rate of 0.85 percent.
While the law has changed more than once on this issue, current guidance states that borrowers who put down less than 10 percent on an FHA loan must pay for FHA mortgage insurance until the entire loan term is over. If you put down at least 10 percent, however, you can have FHA MIP removed after 11 years of payments.
“The length of time that a borrower pays the monthly mortgage insurance premium varies depending upon the original loan terms,” Boomer says.
PMI on a conventional loan, on the other hand, can typically be cancelled once a homeowner has 20 percent equity in their home.
If you’re using an FHA loan program, you will pay mortgage insurance. All FHA loans involve mortgage insurance, either for the life of the loan or for a set number of years. You can avoid FHA mortgage insurance by:
Paying for FHA mortgage insurance for 11 years or longer might sound like a drag, but the expense doesn’t have to last forever.
Many borrowers use FHA loans as a stepping stone that can help them reach the dream of homeownership, 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 acquire more equity in their homes so they can refinance out of their FHA loan into a conventional loan with better terms.
“The FHA is a wonderful starter loan but, at some point, it can also be beneficial to refinance out of it for lower monthly payments, including no [mortgage insurance premiums] or PMI,” Acosta says.
It’s also possible to get out of FHA mortgage insurance by paying down your mortgage, but that can take a significant amount of resources to do. Before paying off your loan, make sure to weigh the financial pros and cons.
The speed at which you can have mortgage insurance removed is obviously very different among FHA loans and conventional loans, but the costs are another key differentiator.
The amount you pay for PMI can vary depending on your credit score and down payment amount. For borrowers with excellent or very good credit (FICO scores of 740 or higher), PMI payments can be lower. As described above, annual mortgage insurance premiums for FHA loans vary based on the loan term and loan amount.
The mortgage insurance deduction was brought back at the end of 2019. Because of this, you might be able to itemize FHA upfront MIP for tax year 2021, and also retroactively for tax years 2018, 2019 and 2020. It’s best to speak with a tax professional, however, to ensure you’re maximizing this deduction if you’re eligible.
Here are some of the advantages of FHA MIP:
Here are some of the disadvantages of FHA MIP:
It’s understandable to worry about the high costs of FHA mortgage insurance. Forking over an upfront premium is already a tough pill to swallow, and paying additional premiums for years or even decades can really eat into your budget.
FHA mortgage insurance doesn’t have to be paid forever, however, depending on your down payment amount or if you refinance out of 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 find it difficult 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 helpful,” Acosta says.
With additional reporting by Holly Johnson and TJ Porter
Bankrate.com is an independent, advertising-supported publisher and comparison service. Bankrate is compensated in exchange for featured placement of sponsored products and services, or your clicking on links posted on this website. This compensation may impact how, where and in what order products appear. Bankrate.com does not include all companies or all available products.
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