If you finance a home with a Federal Housing Administration (FHA) loan, you pay mortgage insurance premium (MIP). MIP is a form of insurance that protects the lender if you default on the mortgage. If you do default, the FHA will reimburse the lender for the unpaid loan balance.
Yes, you pay for MIP, but MIP protects the lender. Still, MIP does benefit you as a borrower. When an FHA mortgage is referred to as a “government-backed loan,” this insurance is what constitutes that backing. By keeping the FHA program financially stable, MIP is giving you the opportunity to buy a home even if you don’t qualify for a conventional mortgage.
How mortgage insurance premium works
When you buy a home with an FHA mortgage, you have two types of MIP payments: up-front and annual.
Your up-front MIP (UFMIP) payment happens when you close on the home purchase. Equal to 1.75% of the loan amount, you can pay UFMIP in a lump sum as part of your closing costs. As an alternative to the lump-sum payment, you can add UFMIP to the mortgage balance. Doing so spreads out that lump sum over the entire term of your loan.
Your annual MIP (AMIP) is based on a rate the lender determines during the mortgage approval process. This rate varies from 0.45 to 1.05% of the loan amount, and is determined based on how much you borrow, your down payment, and the loan term. The annual premium is then calculated by taking the average of your monthly loan balances in a given year and multiplying that by the AMIP rate. That number is then divided by 12 to produce your monthly payment.
How much MIP costs
Here’s an example, using one of the many MIP calculators available online:
Say you buy a home for $200,000. With a 650 FICO® credit score, you’re approved for a 30-year, fixed-rate FHA loan at a 5% interest rate. Your down payment is 3.5%, or $7,000. Your initial loan balance is thus $193,000, and your monthly mortgage payment (principal and interest only) is $1,036.
According to the calculator:
- The UFMPI is $3,377.50. You can pay this as a lump sum when you close, or you can add it to your loan balance. Adding it to your loan bumps up your monthly mortgage payment to $1,054.
- The AMIP is $1,629.47 for your first year, based on an AMIP rate of 0.85%. This number is divided by 12 to get $135.79. You pay this along with your monthly mortgage payment.
Canceling mortgage insurance premium
MIP is not always permanent. Depending on when you completed your FHA loan application and the amount of your down payment, MIP may eventually expire.
For applications completed on or after June 3, 2013:
- If your down payment was less than 10%, MIP will last the life of the loan.
- If your down payment was more than 10%, MIP will expire after 11 years.
For applications completed before June 3, 2013:
- If your down payment was less than 22%, MIP will expire once your loan-to-value (LTV)* the ratio is 78% and the loan is at least 5 years old.
- If your down payment was more than 22%, MIP will expire after 5 years.
Refinancing to get rid of mortgage insurance premium
Another possible way to get rid of MIP is to refinance your mortgage. This becomes an option after you’ve paid off a portion of the mortgage and built some financial equity in your home.
With refinancing, you take out a new mortgage that pays off the original mortgage balance. Your equity acts as a down payment on the new mortgage. The new mortgage should help you save money either through a lower interest rate, no need for MIP, or a combination of the two.
You have to weigh several factors when deciding whether to refinance. Your mortgage lender can review your options to help you determine the best path forward.
Mortgage insurance premiums may be tax-deductible
Your MIP payments may help you save a bit of money at tax time. If you itemize your deductions using Schedule A of your IRS Form 1040, you can deduct the cost of your MIP along with any interest paid on your mortgage.
To complete this deduction, you’ll need a Form 1098 from your mortgage lender (the lender is required to send it to you annually). This form shows the amount of money you paid for MIP during the year.
To further qualify for the deduction, you need to meet specific requirements for your adjusted gross income (AGI).
- The full deduction is available for people whose AGI is less than $100,000 if filing jointly or $50,000 if filing separately.
- A reduced deduction is available for people whose AGI is between $100,000 and $109,000 if filing jointly or $50,000 and $54,500 if filing separately.
- The deduction is eliminated for people whose AGI is more than $109,000 filing jointly or $54,500 filing separately.
Check with a qualified tax advisor to make sure you can include the deduction on your return.
Mortgage insurance premium versus private mortgage insurance
If shopping for a home has you looking at both FHA and conventional mortgage loans, you should understand the differences between MIP and private mortgage insurance (PMI).
Borrowers are required to pay for PMI with some conventional mortgage loans. PMI essentially does the same thing as MPI by providing the lender with financial protection when they underwrite “higher-risk” borrowers.
Key differences include:
- PMI is required only for mortgages with less than a 20% down payment.
- If a mortgage is required to have PMI, the lender will buy the coverage from a private insurer and pass the cost to the borrower.
- PMI is usually paid as part of the monthly mortgage payment; there’s no up-front premium paid at closing.
- An annual premium is calculated by multiplying the loan balance by a PMI rate. This annual premium is divided by 12 to produce the monthly payment amount.
- PMI rates range from 0.2% to 2.0%, according to Experian. This rate is based on the borrower’s down payment and credit score.
- The borrower can request PMI be canceled when the LTV ratio reaches 80%. The lender is required to cancel PMI automatically when the LTV ratio is 78%.
Ask your lender for guidance
Mortgage insurance — whether in the form of MIP or PMI — is just one of several factors you need to weigh when deciding which type of loan is right for you. Your mortgage provider should offer to show you multiple loan options and help you decide which one best meets your needs.