Getting a loan from the Federal Housing Administration (FHA) is an attractive option for homebuyers with less-than-stellar credit who aren’t sitting on a large nest egg. Buyers with a credit score as low as 580 can make a down payment as low as 3.5% of the total purchase price for an FHA loan. But in approving this type of loan, lenders may be taking on quite a bit of risk. That’s why all FHA loan borrowers are required to pay a mortgage insurance premium (MIP) that protect lenders in the event that the borrower defaults on their loan.
This year, the Department of Housing and Urban Development (HUD), through the FHA, actually lowered the annual mortgage insurance premium by 0.30 percentage points, from 0.85% to 0.55% for most new borrowers. That means an average savings of $800 per year for buyers with an FHA-backed mortgage.
Still, homebuyers interested in pursuing an FHA loan should have an idea of how much of an MIP they’ll have to pay—on top of their mortgage principle and interest. Here’s what you need to know about MIP, including the rate you can expect to pay and how these fees actually benefit homebuyers who qualify for FHA loans.
What is MIP?
Essentially, MIP is an insurance policy required by the government on an FHA loan. Since the down payment on FHA loans can be as little as 3.5% of the total price, the government requires added financial protection.
“The purpose of mortgage insurance is to protect the lender, not the borrower,” says Brian Sullivan, a media relations specialist at the Federal Deposit Insurance Corporation (FDIC) who used to work at the FHA. “With FHA loans, the insurance is to protect the federal government in the event a borrower defaults on the mortgage.”
How does MIP work?
When you receive approval for a loan, the FHA will require you to pay an upfront MIP (UFMIP) at the time of closing and an annual MIP, which is calculated every year and paid once a month.
Currently, the UFMIP rate is 1.75% of the amount of your FHA loan. For example, if you borrow $250,000, your upfront costs would be $4,375. The current annual premium rate is 0.55% for most FHA loans.
The UFMIP will be part of the total closing cost, which include your mortgage principal, interest, property taxes, and homeowners insurance. You can also roll the cost of the UFMIP into your escrow payments.
How does MIP benefit the homeowner?
The MIP protects the lender, but this fee is also what allows buyers to put as low as 3.5% down on a home. Essentially, an MIP puts homeownership in reach for many who wouldn’t be able to afford it otherwise.
“Lenders are much more willing to lend money for the purchase or refinance of a home knowing they’re protected against loss,” Sullivan says.
Can you cancel an MIP policy?
Most homeowners will maintain the MIP for the life of their FHA loan. But there are ways to cancel or drop your MIP.
If you got an FHA loan after June 3, 2013 and you put down 10% or more when you bought your home, the MIP may expire after making on-time payments for 11 years.
You can also refinance your FHA loan to a conventional loan. It’s important to note that if you don’t have 20% equity in your home, you’ll still have the requirement of carrying private mortgage insurance until you reach that threshold.
