One of the benefits of taking out an FHA mortgage is that it doesn't require the standard 20 percent down payment necessary to qualify for a conventional mortgage. This allows many borrowers to achieve the dream of homeownership sooner without having to wait until they can save the substantial amount for the down payment. The trade-off for the low down payment is monthly mortgage insurance (MI) that can cost hundreds of dollars a month. Eventually, many borrowers find themselves looking for a way to drop the MI premium from their monthly mortgage payment.
What Is Mortgage Insurance?
Conventional loans require a 20 percent down payment to offset the lender's risk when financing a mortgage. With a conventional loan, the lender is guaranteeing only a maximum loan amount of 80 percent of the purchase price. With a government loan like an FHA mortgage, lenders require only a 3.5 percent down payment, increasing the loan guarantee to a maximum loan amount of 97.5 percent of the purchase price. To insure against potential losses, FHA loans require a monthly mortgage insurance payment separate from homeowners insurance. This is escrowed, or rolled into, the monthly mortgage payment. The borrower makes the monthly mortgage insurance payment to the lender, who then forwards it to the U.S. Department of Housing and Urban Development, the agency insuring the FHA mortgage.
How Much Does Mortgage Insurance Cost?
At the onset of an FHA mortgage, there is a 1.75 percent upfront fee based on the total loan amount. This is the premium that covers the first 12-months of the loan and that must be financed into the loan or paid in cash at closing. The first monthly mortgage insurance installment is due with the first mortgage loan payment and is calculated with a fixed rate established by the U.S. Department of Housing and Urban Development. As of 2018 the rate is .85 percent of the loan amount.
When Is the Mortgage Insurance Premium Eligible for Removal?
As of January 2018, mortgage insurance is required for the life of an FHA loan. The only way to end the MI obligation is by paying the loan in full either by refinancing to a conventional mortgage or by making the final loan payment. There is a bill being proposed in Congress called the Making FHA More Affordable Act of 2017 that proposes to return to the policy that was in place prior to the January 2013 change. At that time there were three additional ways to end mortgage insurance payments, according to the Consumer Financial Protection Bureau. The payment could be removed once your loan reached the halfway point – for a 30-year mortgage that would be after 15 years of payments. Or, you could submit an appraisal showing that your home's value had increased by 22 percent. And last, the premium would end on its own based on a date the lender had provided during the signing of the closing documents. In all cases of early termination of mortgage insurance, the loan must have been paid as agreed and currently in good standing with the lender.
If this proposed bill eventually passes Congress and is signed into law, those options will once again be available to qualifying borrowers looking to remove their mortgage insurance premiums. Until then, refinancing into a conventional mortgage or paying your FHA mortgage in full are the only ways to remove mortgage insurance payments.