Have you ever availed of mortgage insurance? Do you know about mortgage insurance premiums? Who benefits from this insurance? This article offers comprehensive information to help you understand the topic and make wise decisions.
Mortgage insurance premiums (MIPs) pay for insurance to protect mortgage lenders against borrowers’ risk of not paying them back. MIP is an additional charge to a borrower’s costs. However, they allow you to buy a house with a lower down payment than the usual 20%. There are different kinds of mortgage insurance premiums, which differ in amount, timing, and other rules.
Mortgage Insurance premiums (MIP) are paid by the homeowners who purchase mortgage insurance. Homeowners receive loans in the form of mortgage insurance, which is backed by the Federal Housing Authority (FHA). Before the 2017 Tax Cut and Jobs Act, mortgage insurance premiums were deductible in addition to permissible mortgage interest. Notwithstanding, the Further Consolidated Appropriations Act of 2020 allows tax deductions for MIP and private mortgage insurance (PMI) for 2020 and retroactively for 2018 and 2019.
Mortgage insurance premiums and private mortgage insurance help lenders offer home loans to customers who can not otherwise qualify. The purpose of mortgage insurance is to protect lenders against losses when a borrower is at default. Hence, every FHA-borrower pays the mortgage insurance premiums.
FHA mortgages offer great perks for first-time home buyers. However, to avail this loan program, the borrowers need to meet the Federal Housing Administration requirements and your FHA-approved lender. FHA loans are available to those who meet the following qualifications:
- A credit score of 580 or higher
- A 3.5% down payment
- A debt-to-income ratio of 43% or less
- 1-2 years of consistent employment history (most likely two years if self-employed)
- A property that meets FHA standards or is eligible for FHA 203k financing
- A loan amount within 2022 FHA loan limits; which is currently $420,680 in most states
The Federal Housing Administration (FHA) oversees a program of loan insurance to give more homeownership opportunities to USA citizens. FHA provides mortgage insurance to FHA-approved lenders to protect these lenders against losses if the homeowner defaults on loan. The cost of the mortgage insurance passes along to the homeowner. The standards for qualifying for these loans are generally more flexible than conventional ones.
Now you must be thinking if the purpose of this mortgage insurance is to protect the lender, then why the borrower must pay?
To find out more, read ahead!
What is mortgage insurance and how does it work?
Mortgage insurance is an insurance policy, which gives protection to mortgage lenders or titleholders if the borrower defaults to make a payment, passes away, or for any other reason is unable to meet the contractual obligations. Mortgage insurance pays the lender a portion of the principal if a borrower stops making mortgage payments. However, a borrower is still accountable for the loan if compensation is due, and they could lose the home in foreclosure if you fall too far behind.
If you are wondering why the lender is being protected in this case? Then let’s remind you of the mortgage crisis that happened in the USA. During the late 2000s, due to the subprime mortgage crisis, numerous insurance companies suffered and even went down because of the high number of claims on mortgage insurance policies due to subprime mortgage crisis. The severity of the problem vindicated the U.S. Treasury to interfere and lend emergency funds to suppress the effects on the financial system.
How does mortgage insurance work?
There is a high degree of risk for lenders in executing home loans. To minimize the risk, the lenders purchase mortgage insurance plans. These policies are made to compensate mortgage lenders for losses caused by payment offenses as well as the death or disability of the borrower. For instance, if the borrower of a $100,000 mortgage loan dies, leaving a $40,000 balance on the mortgage, the lender’s mortgage insurance covers only the remaining balance of $40,000.
Mortgage insurance often comes with classic pay-as-you-go premium payment, or you can finance it into a lump-sum payment at the time of mortgage origination. Due to the 80% loan to value ratio, homeowners need to have Private Mortgage Insurance (PMI). Nevertheless, the borrowers can request the insurance policy cancellation upon request once they have paid 20% of the principal balance.
Types of mortgage insurance
Mortgage insurance works differently depending on the type of home loan. Mortgage insurance can refer to three types of mortgages:
Qualified mortgage insurance premium
When a borrower gets a U.S. Federal Housing Administration (FHA)-backed mortgage, they must pay a qualified mortgage insurance premium, which provides the akin type of insurance. MIPs have different rules, including that everyone who has an FHA mortgage must buy this type of insurance, regardless of the size of their down payment.
Private mortgage insurance (PMI)
A borrower needs to purchase this insurance plan as an obligation to conventional loans. Like other insurance plans, private mortgage insurance protects the lenders, not the borrowers. The lender’s responsibility is to arrange the private mortgage insurance through private insurance companies. A lender might require PMI if a borrower is refinancing with a conventional loan and equity is less than 20% of home value.
Mortgage Title Insurance
Mortgage title insurance protects against loss if a sale does not remain validated because of a problem with the title. Mortgage title insurance protects a beneficiary against losses if it determines that someone other than the seller owns the property at the time of the deal.
Before mortgage closing, a representative, such as a lawyer or a title company employee, performs a title search. The process helps prevent the owner from selling the property. A title search also verifies that the real estate being sold belongs to the seller.
What is a qualified mortgage insurance premium (MIP)?
There are different kinds of mortgages having different types of names. Each mortgage has various payment methods. If you are a borrower of a Federal Housing Administration (FHA) backed loan, most likely you have to pay the mortgage insurance premium.
Mortgage insurance premium (MIP) is an additional fee that borrowers pay to protect the lender in case of default, which is the essential requirement for any Federal Housing Administration (FHA) home loan, irrespective of the down payment size. It protects the lender in case the borrower defaults on the loan. The FHA mortgages make it compulsory for every borrower to have a mortgage insurance policy. However, conventional loans only need private mortgage insurance (PMI) policies if the down payment amount is less than 20% of the property’s purchase price.
FHA mortgage insurance is compulsory for all FHA loans. It costs the same regardless of your credit score, with only a slight increase in price for down payments of less than 5%. FHA mortgage insurance includes both an upfront cost, paid as part of your closing costs, and a monthly cost included in your monthly payment.
If the borrower does not have enough cash on hand to pay the upfront fee, the FHA allows them to move the payment into your mortgage instead of spending it out of pocket. However, if a borrower does this, the loan amount and overall loan cost will increase.
There are two types of mortgage insurance premiums associated with FHA loans:
- Up Front Mortgage Insurance Premium (UFMIP): Up-front mortgage insurance is an insurance premium collected at the initiation of a loan. Up-front mortgage premiums add to a pool of money used to help entities like the FHA-insured loans for specific borrowers. These insurance premium payments directly go into the US Department of Housing and Urban Development (HUD), and the US Department of the Treasury collects them through automated collection service. They go into an escrow account.
- Monthly Mortgage Insurance Premium: The borrower needs to pay these premiums monthly along with the principal amount, interest, taxes, and insurance.
Let’s help you understand these two by charting out the differences.
|A one-time payment equal to 1.75% of the loan amount, regardless of LTV||A periodical fee built into every monthly mortgage payment amount|
|UFMIP can be paid at closing or rolled into the cost of the loan||Calculating the cost of monthly MIP depends on the size of a loan’s down payment:
● For a down payment between 3.5%—5%: 0.85% of the loan amount divided by 12
● For a down payment 5% or higher: 0.80% of the loan amount divided by 12
|If moving into a loan, this amount does not count toward the LTV of the loan or the standard FHA loan limit||The duration of annual MIP payments depends on the down payment amount:
● If the down payment is less than 10%, MIP will last throughout the life of the loan (until sold off, paid off, or refinanced)
● If the down payment is 10% or more, MIP will last for 11 years.
How does mortgage insurance premium work?
Each FHA loan requires an upfront premium of 1.75% of the loan amount and an annual premium of 0.45% to 1.05%. Payment of upfront premiums depends on the loan issuance. Determination of the exact yearly cost comes from the loan term, the amount borrowed, and the loan-to-value ratio.
- Before we move on, let us help you understand what the loan-to-value ratio is? It is an assessment of lending risk, which financial institutions or other lenders examine before approving the mortgage. Usually, loan assessments with high LTV ratios are considered higher-risk loans. Therefore, if the lender approves the mortgage, the loan has a higher interest rate if the lender approves the mortgage.
The FHA loan requires a borrower to pay monthly mortgage insurance premiums. Each month, the loan’s payment amount reflects the annual premium divided by 12 months along with the principal payment. Other charges usually add to the monthly fee, including escrow amounts for property taxes and homeowner’s insurance coverage.
How do you cancel the mortgage insurance premium?
Using an FHA loan program, you will pay mortgage insurance. All FHA loans involve mortgage insurance, either for the life of the loan or for a set number of years.
The borrower will use a different lending program to cancel FHA mortgage insurance. It means opting for a conventional loan with a 20 percent down payment. However, there are other options as well. One option is accepting an FHA loan and the MIP that it comes with, then refinancing into a non-FHA loan once you’ve built enough equity in your home.
If the borrower is not willing or able to make a 20 percent down payment, another option is a lender-paid mortgage insurance (LPMI) loan. In this type of loan, the lender can cover the private mortgage insurance (PMI) in exchange for a higher interest rate. Furthermore, there is another option known as a piggyback loan. This loan allows a borrower to make a 10% down payment and gets a second mortgage to add another 10 percent to your down payment. The borrower ends up with a 20 percent down payment overall, avoiding PMI; however, the borrower will have to pay two loans.
What are the tax implications of mortgage insurance premiums?
Every year, your lender is required to send a form (Form 1098), Mortgage Interest Statement to both borrower and the International Revenue System (IRS). This form consists of lists of your mortgage payments over the past year and can affect your income tax. The total MIP or PMI premiums will be in box number 5 of the form. The borrower must itemize your deductions using Schedule A under the interest paid section to claim a deduction for either type of mortgage insurance.
The deduction for these premiums expired on Dec. 31, 2017, due to the passage of the Tax Cuts and Jobs Act of 2017. However, when the Further Consolidated Appropriations Act, 2020 passed, Congress extended the deduction through Dec. 31, 2020. It indicates that the deduction was available for the 2019 and 2020 tax years and retroactively for 2018 taxes.
Mortgage insurance premium calculator
The mortgage insurance premium calculator allows the potential borrower to know about the affordability. There are multiple mortgage insurance premium calculators available, which gives a suitable estimate of the cost of insurance premiums. You can use this calculator to compare your mortgage insurance premium estimate with different down payments.
All new FHA borrowers pay a premium into an insurance fund that reimburses lenders when a borrower goes into foreclosure. The insurance fund and promise of repayment backed by the U.S. government give lenders the confidence to lend money to people who might not qualify for a conventional loan. There are two FHA mortgage insurance premiums new borrowers need to pay: an “Upfront Mortgage Insurance Premium” (UFMIP) and an ongoing annual fee calculated every year. If the loan balance falls, the yearly premium is recalculated and decreases.
The FHA uses a specific formula to determine the cost of mortgage insurance premiums. This formula requires the loan amount, the amount of the down payment and the number of years the mortgage lasts, along with other details such as purchase price, terms, interest rate, property tax (yearly), and homeowners insurance.
The easiest way to estimate your monthly MIP is to use an online calculator. Using FHA’s online What’s My Payment calculator, you need to input the following information:
- Purchase price
- Size of your down payment
- Interest rate
- Loan term
- The name of the state where the home is
The calculator provides an estimate for your total payment based on that information. As part of an estimate, it gives you the dollar cost of your FHA mortgage insurance premium. This calculator provides the borrower with the closest possible approximate payment on an FHA-insured loan; however, a mortgage broker can offer you the best rate in the market.
Upfront mortgage insurance premium calculator
Most FHA-backed loans make it compulsory for borrowers to pay upfront mortgage insurance premiums (read the before-mentioned reasons). However, these FHA loan programs allow borrowers to finance this cost into the mortgage. As discussed earlier, mortgage insurance protects lenders because loans with less down payment are riskier than loans with more equity.
The UFMIP premiums are found as a percentage. Hence there is no fixed dollar amount for either UFMIP or MIP. Each loan program varies from others, so actual dollar amounts depend on the calculations provided by your lender. Furthermore, as per rules stated by the US Department of HUD, “The UFMIP is not refundable, except in connection with the refinancing to a new FHA-insured mortgage.”
Apart from the FHA calculator, numerous calculators are available to calculate upfront mortgage insurance premiums, such as Forthright Funding’s mortgage calculator, money geek calculator, HSH’s mortgage insurance premium calculator. These tools will help you find the best possible estimate of the upfront mortgage insurance premium you need to pay.
Monthly mortgage insurance premium
All FHA-backed loans include the monthly mortgage insurance premiums. The monthly mortgage insurance premium rate is between 0.5% to 1.05% of the loan amount adhering to the loan terms and down payment. Referring to the image shown below, if the borrower takes up the 30-year loan of $200,000 and pays the minimum down payment of 3.5%, the MIP will be 0.85%.
According to the US Department of Housing and Urban Development, the formula for calculating monthly mortgage insurance premiums came into effect from May 1, 1998 (the details are available on their website under Mortgage Letter 98-22 attachment). The potential borrowers of FHA loans can easily find the formula and detailed examples of calculations on the website of the US HUD’s department. It must clear all of your doubts as a borrower. Furthermore, you can always meet their representative to seek more assistance.
Mortgage insurance premium at closing
It gets incredibly overwhelming while you dig into mortgage insurance premiums to purchase a house. Buying your home is like a dream come true. However, understanding the nitty-gritty of mortgage insurance premiums will make you exhausted. Each deal is different, so it can be hard to restrict hard and fast answers on whether or not mortgage insurance premiums roll into closing fees. In some cases, the borrower can pay at closing, and this cost may be included in a “cash to close” statement provided by the lender.
In the USA, mortgage insurance premiums usually fall into the prepaid costs classification of your closing costs. Prepaid items have no direct relation to the home purchase, though these are usually a requirement from the lender, and the borrower must pay in advance.
Mortgage insurance premiums are typical to help lenders minimize the higher risks of borrowers being at default. If the borrowers intend to purchase a house, they must abide by the rules of the Federal Housing Administration. The FHA-backed loans provide loans to people with low financial capacity. However, the mortgage insurance premium is for the lender’s protection. There are two kinds of mortgage insurance premiums: upfront mortgage insurance premium and annual mortgage insurance premium. Both have different requirements considering the type of loan and other relevant details. Borrowers who cannot provide a down payment of less than 20% can avail of an FHA-backed loan with as low a downpayment as 3.5%. This program helps them to buy their own house.