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In the past three years, the Federal Housing Administration (FHA) has changed its rules regarding private mortgage insurance (PMI). These rules have changed the entire nature of PMI as it applies to FHA mortgages, specifically.
Though the FHA tweaks rules frequently, there have actually been two significant changes: one good, and the other not good at all.
The good change is that FHA lowered its mortgage insurance premiums in January 2015. On the negative side, they’ve made PMI essentially permanent over the life of most mortgages that they insure.
The Good News: Lower PMI on FHA Mortgages
FHA made the announcement in January of 2015 that FHA insured mortgages originated after January 26, 2015 would be assessed lower PMI charges.
It’s important to understand that, unlike conventional loans, FHA actually imposes two different PMI charges on mortgages that it insures. (Note: FHA documentation actually refers to PMI as mortgage insurance premium or MIP).
- Upfront MIP, or UFMIP, which is a one time flat fee that is charged as a percentage of the new mortgage, and
- Annual (or monthly) MIP, which is a recurring charge that is based on a percentage of the outstanding mortgage balance, and added to the mortgage payment each month.
FHA charges an UFMIP premium equal to 1.75% of the new mortgage balance. That rate did not change with the January 2015, announcement. However, monthly MIP did drop, and substantially at that.
FHA has varying rates on annual MIP, depending on the size of the loan and the amount of the down payment. But on what is by far the most common loan type for FHA borrowers (30-year mortgage with less than 5% down, and a loan balance of up to $625,500) the annual premium rate dropped from 1.35% down to 0.85%.
What this means is that had you taken a $200,000 mortgage prior to January 26, 2015, the annual premium would be $2,700 ($200,000 X .0135), or $225 per month. But as of now, it would be just $1,700 ($200,000 X .0085), or $141.67 per month.
Be aware that annual MIP is calculated based on the outstanding mortgage balance, not on the original amount of the loan. As the loan balance declines, the annual MIP premium will decline with it. Still, the reduction in the premium rate could save you a load of money over the life of your loan.
The Bad News: FHA Monthly MIP Can’t Be Canceled
On conventional loans, PMI can be canceled once you’ve paid the loan down to 80% or less of the original value of your home. Furthermore, the lender is required to remove PMIeven without any action from you once the loan is paid down to 78% of the original property value, as long as you’re current on your payments. This means that with a conventional loan, your total mortgage payments will eventually drop when you’ve paid down your mortgage balance.
That used to be the case with FHA mortgages, too. But it all changed when the FHA issued revised guidelines effective for loans originated on or after April 1, 2013. Facing continued increases in claims on defaulted mortgages, FHA was forced to implement permanent MIP premiums in order to cover its losses. (It’s worth noting that in the same ruling, FHA also increased monthly MIP rates by 10 basis points on all loan types.)
What that means is that on most FHA mortgages you will continue paying annual MIP for the entire life of the loan. Almost.
The FHA has actually created two different schemes for MIP. For loans on which the homebuyer makes a down payment of 10% or more, annual MIP will cancel at either the end of the loan term, or after 11 years, whichever comes first.
For any loans that include a down payment less than 10%, annual MIP will continue for the life of the loan. Unfortunately, loans with down payments of less than 10% represent the vast majority of FHA loans, since the FHA only requires a down payment of 3.5%. The loan term doesn’t affect this rule, whether you take outa 15-year mortgage or a 30-year mortgage.
It’s also worth noting that if your FHA mortgage originated prior to April 1, 2013, you’re still eligible to have the annual MIP canceled based on the original rules. The elimination of the cancellation provision applies only to loans originated after that date.
How Can You Get Rid of MIP on an FHA Loan?
There are basically two choices here: 1) pay off your FHA mortgage or 2) refinance your FHA mortgage into a conventional loan that does not require PMI.
The first option is fairly self-explanatory. If you pay down your FHA mortgage early, you’ll wind up paying less in MIP than you would have otherwise. But you’ll still need to make the PMI payments each month over the life of your loan.
On conventional loans, PMI is typically required only if you purchase a home with a down payment of less than 20% or if you refinance your current home, and a new mortgage will exceed 80% of the property’s appraised value. The key to taking a conventional mortgage with no PMI refinance on your home is when you’ll have at least 20% equity in the loan.
This can happen either because the market value of your home has increased since you bought the house or because you’ve paid down the mortgage balance to the point where it doesn’t exceed 80% of the property’s appraised value. Either way, your new conventional mortgage won’t require PMI if you refinance at this point.
Should You Refinance into a Conventional Loan?
Oftentimes, homebuyers opt for a more-expensive FHA loan because it has looser credit score requirements. However, conventional mortgages have some advantages over FHA loans, including no upfront MIP payments and potentially lower PMI premiums.
With conventional mortgages, though, PMI premiums for low down payment mortgages vary depending on your credit score. Right now, the premiums can range anywhere from 0.55% if you have a credit score of at least 760, to 2.25% for a credit score as low as 620.
So even if you haven’t built up the 20% equity you need to get rid of PMI payments altogether, you may want to consider moving into a conventional mortgage. If you have a high credit score that will net you a very low PMI premium rate, a refinance may be worth your while. But if you have a low credit score, a refinance could actually saddle you with larger PMI payments, making your monthly mortgage payments higher.
One Other Option for Avoiding PMI
There is yet one more way to avoid PMI on a conventional loan, and that’s by doing a first/second combination. That’s where you take a new first mortgage equal to 80% of the value of your property, and then cover the remaining balance through the use of a second mortgage or home equity line of credit (HELOC).
It should be understood however that the first/second combination is generally not an option if you have a low credit score. This is because the credit score requirements for second mortgages and HELOCs are generally higher than for conventional first mortgages.
Typically, however, a first/second refinance combination will be limited to an 80% new first mortgage, and a 15% second mortgage or HELOC. That means that your current mortgage cannot exceed 95% of the value of the property; otherwise, you’ll have to put up additional cash in order to lower the loan balance to that level.
But if you can use either refinancing strategy to turn your FHA mortgage into a conventional mortgage with no PMI or lower PMI, you can eliminate your FHA mortgage and the PMI that it will charge for the life of the loan.