Many first-time home buyers will discover that they have to pay for something called “mortgage insurance.” This adds to your monthly mortgage payment and is often an unpleasant surprise. This is especially true if you’re seeking an FHA loan, which is structured for families with less money or poor credit than a conventional mortgage. Fortunately, you can eventually remove FHA mortgage insurance from your monthly payments, but if you’ve had a mortgage since 2013, it may require refinancing. If you need help planning a home purchase, consider talking to a financial advisor
What is mortgage insurance?
Mortgage insurance is a financial product that protects your lender if you default on your mortgage. If you default, the insurer will pay the remaining balance of the loan to your bank.
Mortgage insurance has become an increasingly common feature of the housing market in recent years. Typically, lenders require this product when homebuyers have less than a 20% down payment.
As home prices continue to rise, mortgage insurance has moved from a relatively niche product to a central part of the housing process – And it’s not cheap. Mortgage insurance can be between 0.5% and 2% of the original mortgage per year. For FHA loans, however, the government recently reduced insurance premiums by 30 basis points – 0.85% to 0.55% – Every year for most home buyers.
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PMI vs. FHA Mortgage Insurance
There are two main types of mortgage insurance: PMI and MIP.
Private mortgage insurance or PMI is charged to home buyers who take out a conventional mortgage from a private lender. As mentioned above, lenders generally require this for any mortgage when the down payment is less than 20%. It usually goes away automatically after your home equity reaches 22%, you can ask your lender to remove the charge once you reach the 20% equity threshold.
The mortgage insurance premium or MIP is what you pay if you have a loan from the Federal Housing Administration. These mortgages typically have lower down payment requirements than conventional loans and often lower credit requirements as well. They are intended to help first-time and low-income buyers buy a home. While backed by the government, these loans are issued and managed by third-party lenders.
Unlike conventional mortgages, which only require mortgage insurance if the down payment is below 20%, FHA loans always require MIP. You must pay an upfront premium worth 1.75% of the total mortgage, then an annual premium. And unlike private mortgage insurance, it doesn’t always stop once you reach a certain value of equity.
How to Remove FHA Mortgage Insurance
In some circumstances, you can remove MIP from your monthly payment, and there are two main ways to do this: MIP cancellation and refinancing.
Cancellation of MIP
For many homeowners, this can be difficult due to changes in FHA regulations. MIP cancellation options depend on when you took the loan.
If you took your loan before 2000 you cannot apply for MIP cancellation.
If you took out your loan between 2001 and 2013, you can apply for MIP cancellation if:
Note that this process should be automatic. If it isn’t, contact your lender to specifically apply for it.
If you took out your loan after 2013, you can apply for MIP cancellation if:
Unfortunately, you will never qualify for MIP cancellation if you took out a mortgage after 2013 and made less than a 10% down payment. Mortgage insurance and all associated costs will be a permanent component of your loan.
Refinancing
The FHA mortgage program has strict requirements and many borrowers will not qualify for MIP cancellation based on the terms of their original loan. In these cases, the best option is usually to consider refinancing into a conventional mortgage.
The advantage of refinancing is that you pay off your FHA loan completely. You take out a new mortgage and use it to pay off existing debt, effectively changing the nature of your debt from one lender or product to another. That said, refinancing usually comes with all the requirements of a conventional mortgage. Specifically:
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A relatively high credit score, usually in the mid-600s and above
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Minimum 20% equity in home to avoid PMI
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Closing costs
You usually don’t have to make a new down payment to refinance, but the lender will want to see significant equity in the home. Depending on your specific situation that could mean 10% or even 5% in some cases, but if you have less than 20% equity in your home, they will likely require private mortgage insurance. This isn’t the worst option, since PMI can be removed once you reach 20% equity, but it’s important to consider.
Additionally, you need a higher credit score to refinance than to secure an FHA loan. This process will also involve closing costs, which typically range from 2% to 5% of the loan amount. If you want to stay in your home for a while, refinancing can be a great decision, so the savings outweigh the cost. If you’re likely to move in the near future, make sure you’re not eating up your insurance benefits on upfront costs.
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Every FHA loan comes with mortgage insurance or MIP. If you took out your mortgage any time after 2013, you can remove it until your initial down payment is enough. Otherwise your only option is to refinance.
Home buying tips
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Setting a budget and sticking to it is an important part of the home buying process. SmartAsset has tools specifically designed to help you figure out what you can afford and what your mortgage payments will be. And if you’re unsure whether you should continue to rent or buy a home, try our rent vs. buy calculator.
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Buying a home is a huge step, so it helps to have a financial professional in your corner to advise you. Finding a financial advisor doesn’t have to be difficult. SmartAsset’s free tool matches you with three vetted financial advisors who serve your area, and you can interview your advisor at no cost to determine which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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