FHA Mortgage Insurance: Why It’s Necessary And So Expensive

When you buy a home and don’t have at least 20 percent saved for a down payment, mortgage lenders want to protect themselves from risk if you can’t repay the loan. That’s why they require borrowers to pay for mortgage insurance, or FHA MIP, which protects the lender from loss when a borrower can’t repay the loan.

With a conventional loan, private mortgage insurance, or PMI, of up to 1 percent or more of the loan amount is charged every year until you have at least 20 percent equity in your property. Loans insured by the Federal Housing Administration, or FHA, also require mortgage insurance, but it works differently than PMI.

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.

What is FHA mortgage insurance (MIP)?

FHA Mortgage Insurance Premium (MIP), like PMI, is an additional fee you pay to protect the lender’s financial interests in case you default on your loan. FHA borrowers are required to pay two FHA mortgage insurance premiums — upfront at closing, and annually for as long as you repay your FHA loan, in most cases.

How much does FHA mortgage insurance cost?

Here’s a look at the premium pricing for upfront and annual mortgage insurance premiums for FHA loans:

  • An upfront mortgage insurance premium, which is equal to 1.75 percent of the loan amount
  • Annual mortgage insurance premiums, which are equal to .45 percent to 1.05 percent of the loan amount each year of your loan term

Upfront mortgage insurance premiums can, and often are, financed into the loan amount, says Peter Boomer, a mortgage executive with PNC Bank. Annual premiums are included in the borrower’s monthly mortgage payment.

Monthly mortgage insurance premium amounts are also determined by the loan term — whether an FHA loan is 15 or 30 years — and the initial loan-to-value ratio on the home when the borrower takes out the loan.

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It’s important to recognize that upfront FHA MIP will slightly increase your loan amount. For example, if you borrow $100,000 and wrap the cost of upfront mortgage insurance 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 loan  with a 4 percent interest rate, your monthly principal and interest payment would increase from $477 to $486, or by $9.

Once the annual premium is included, your monthly payment rises even further. Adding the annual premium to the example above would increase your monthly principal and interest payment by $72.07 per month, bringing your total monthly payment to $558. That’s assuming you make a minimum down payment of 3.5 percent, in which case an annual MIP of 0.85 percent is charged.

How long will you pay FHA mortgage insurance?

One of the biggest differences between PMI on a conventional loan and FHA mortgage insurance is the fact that FHA mortgage insurance premiums aren’t optional and cannot be canceled in most cases.

Traditional PMI can typically be removed from a mortgage once a homeowner can prove they have 20 percent equity in their property, but the same can’t be said for FHA mortgage insurance.

“The length of time that a borrower pays the monthly mortgage insurance premium varies depending upon the original loan terms,” Boomer says.

While the law has changed more than once on this issue, current guidance states that consumers who put down less than 10 percent with an FHA loan must pay for FHA mortgage insurance until their entire loan term is over. If you put down at least 10 percent, you can have mortgage insurance removed after 11 years of payments.

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How to get rid of FHA mortgage insurance

Paying for FHA mortgage insurance for 11 years or longer may sound like a drag, but this 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, CEO of the National Association of Hispanic Real Estate Professionals (NAHREP). 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 it can take a significant amount of resources to do so. Before paying off your loan, make sure to weigh the financial pros and cons.

FHA mortgage insurance vs. PMI costs

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.

Source: Federal Housing Administration, Genworth Mortgage Insurance, Ginnie Mae and the Urban Institute

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, or FICO scores of 740 or higher, PMI payments can be lower. Annual mortgage insurance premiums for FHA loans vary based on the loan term and loan amount.

Is FHA mortgage insurance tax deductible?

Mortgage insurance premiums were once tax-deductible, but that’s no longer the case. The FHA MIP deduction expired in 2017.

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The advantages and disadvantages of FHA mortgage insurance

Here are some of the advantages of FHA MIP:

  •  Premiums are set. FHA mortgage insurance premiums don’t fluctuate according to credit score.
  • Easier qualification requirements. FHA mortgage insurance helps borrowers who may not otherwise qualify for a conventional loan. The FHA is able to absorb more risk and therefore extend loans to less-creditworthy borrowers.
  • Lower down payment amounts. Borrowers with a credit score of 580 and up can put down as little as 3.5 percent. Those with FICO scores between 500 and 579 can put down as little as 10 percent.

Here are some of the disadvantages of FHA mortgage insurance:

  •  Adds to the overall cost of the loan. The upfront and annual costs of mortgage insurance increase both your total loan amount and monthly payment.
  • It’s difficult to get rid of. Generally, there are only a couple of ways out of paying for mortgage insurance — you can either refinance into a conventional loan or pay off your mortgage in full.

Bottom line

It’s understandable to worry about the high costs of FHA mortgage insurance. Forking over an up-front premium is a tough pill to swallow, but paying additional premiums for years or even decades can really eat into your budget.

FHA mortgage insurance premiums don’t have to be paid forever, depending on your down payment amount and the option to 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 reporting by Holly Johnson.

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