How Mortgage Insurance Premiums Work
If mortgage insurance was required when you took out your home loan, the thought of getting rid of it has probably crossed your mind. Mortgage insurance (MI) is a double edged sword. It allows borrowers to buy a home with a smaller down payment. But they pay a monthly insurance premium to offload some of the lender’s risk. MI is required when borrowers:
- Purchase a home and make a down payment less than 20% of the purchase price or appraised value, whichever is less.
- Refinance a home and do not keep 20% equity in the home.
As you can see from the two points above, 80% LTV is the universally agreed-upon cutoff ratio. LTV is a measure of risk. If a borrower defaults on a loan while the value of the home is down “a little” from the time of purchase, there’s still some remaining equity that forms a buffer and ensures the lender can sell the home and recoup the principal balance.
There are several types of first time home buyer programs available that allow borrowers to take out a loan with less than 20% when combined with mortgage insurance. You may have taken out one of the following:
- FHA – 3.5% down
- VA – 0% down
- USDA – 0% down
- Conventional – 3% down
Note: Most conventional loans (non-government agency programs) require 20% down. But there are few conventional programs that only require 3% down for well-qualified buyers, such as Conventional 97 and HomeReady. Conventional loans have a unique option called lender-paid mortgage insurance (LPMI). In exchange for a borrower accepting slightly higher interest rate, the lender can pay the mortgage insurance at the time of closing. LPMI means there won’t be a monthly insurance premium tacked on to each house payment.
Mortgage insurance premiums come two flavors, one-time upfront fees and annual fees. Here’s how these two types of premiums work.
Upfront Mortgage Insurance Premiums
If you got an FHA, VA or USDA loan, you paid a mortgage insurance premium at the time of closing. Though, you may not have paid these costs out-of-pocket. In many cases, upfront fees get rolled into the loan. They are present for both purchase and refinance transactions. All of them serve the same purpose. Here are the different names for upfront fees, matched with their respective mortgage programs:
- FHA Loans – Upfront Mortgage Insurance Premium (UFMIP)
- VA Loans – Funding Fee
- USDA Loans – Guarantee Fee
- Conventional Loans – (do not have upfront fees)
Loans funded by Fannie Mae or Freddie Mac, also known as conventional loans, don’t require upfront mortgage insurance premiums.
Upfront fees change from time to time, dictated by prevailing market risk. When things are going well (foreclosures and payment delinquencies are down), the government agencies that manage these insurance pools might lower the upfront fees. Same goes for annual mortgage insurance premiums; they can shift depending on broader economic conditions. Let’s dive into annual premiums, too.
Annual Mortgage Insurance Premiums
Annual mortgage insurance is paid by borrowers until the LTV reaches 78% or 80%, depending upon the program. It’s an annual premium, calculated each year. But it’s broken up and paid in monthly installments. Borrowers include mortgage insurance premiums as part of their overall mortgage payment. You may see the term “HUD Escrow” to describe this on your mortgage statement.
Here are interchangeable names used for mortgage insurance premiums:
- FHA Loans – Mortgage Insurance Premium (MIP)
- VA Loans (do not have annual mortgage insurance premiums)
- USDA Loans – Annual Fee
- Conventional Loans – Private Mortgage Insurance (PMI)
Canceling Mortgage Insurance
Awhile back, when you got your home loan, putting up a small down payment was a sweet deal. But now you want to get rid of mortgage insurance premiums, those irritating extra fees you pay each month as a part of your mortgage payment.
You’re not alone. The mortgage universe is set up to do just that – provide a way for borrowers to cancel mortgage insurance. Mortgage insurance premiums may be terminated automatically or when borrowers make a request in writing to the loan servicers.
In general, to remove mortgage insurance, following conditions must be met:
- There must be at least 20% equity in the home (80% LTV)
- You must be current on your mortgage payments, your ability to pay on-time and in-full matters a lot
- You may be asked to prove there are no other liens on the property such as second mortgages or equity lines.
- Depending on market conditions, an appraisal may be required to show current LTV is 80% or less
Know Your Loan-to-Value
You may have noticed that LTV keeps coming up. It’s the single biggest factor that determines whether canceling mortgage insurance premiums is possible. Thus, it’s worth a closer look. There are two LTV formulas to help you.
First, let’s say you just want to find your home’s current LTV. The loan amount is the current principal balance. The value is the purchase price or appraised value. You’ll want to use the lower number, the purchase price or appraised value, in the formula below:
Loan ÷ Value = Loan to Value
Using this formula, let’s find the LTV on a home that is worth $300,000 and where the mortgage balance is $200,000.
$200,000 ÷ $300,000 = .67
.67 is the same as 67% LTV. Easy, right?
But what if you want to know how much equity you’d need in your home to cancel the mortgage insurance premium? Just multiply .80 by the current home value:
Value x .80 = Principal Balance at 80% LTV
So let’s say you have a home that is worth $400,000, and you want to know what principal balance would be required to cancel mortgage insurance. Using the formula above:
$400,000 value x .80 = $320,000
With a principal balance of $320,000 or less, this mortgage would not need to be insured.
Knowing the loan balance required to reach 80% LTV is a good start. This is the reference point for everything that follows. Now we can take a closer look each type of mortgage program and their specific rules for canceling mortgage insurance.
Getting Rid of Private Mortgage Insurance (PMI)
When required, conventional mortgages (loans held by Fannie Mae or Freddie Mac) carry private mortgage insurance (PMI). If you need to confirm your loan is held by Fannie Mae or Freddie Mac, you can use their lookup tools:
PMI cancellation happens one of two ways; by automatic termination or when a borrower requests it.
Conventional loans have a built-in trigger that removes mortgage insurance premiums when the principal balance reaches 78% of the original value of the property. When the loan originated, the payment schedule was entirely known in advance. Thus, a scheduled termination date could be determined. By law, lenders must disclose the PMI cancellation date to borrowers.
Barring any housing market turbulence, private mortgage insurance should cancels automatically. In markets where home prices have gone down, lenders may invoke their right to request an appraisal to confirm the property’s current value. They’ll want to make sure the LTV is at or below 78%.
Borrowers with mortgages that sit at or below 80% LTV can request private mortgage insurance cancellation. Borrowers must make the request in writing to the current loan servicer.
- Loans must be at least two-years-old to qualify
- Loans between two and five years-old are eligible at 75% LTV
- Loans five years and older are eligible at 80% LTV
Lenders reserve the right to request a new appraisal to determine the current LTV. This right is usually only invoked when market prices have been falling. Otherwise, the original home value (price or appraised value) is used.
Getting Rid of FHA Mortgage Insurance Premium (MIP)
When required, FHA loans (loans insured by the Federal Housing Administration) carry an annual Mortgage Insurance Premium (MIP). MIP cancellation is little more complex than removing mortgage insurance required by other major loan programs.
Only FHA loans of a certain vintage are eligible for automatic FHA MIP cancellation. Automatic termination kicks in when the home reaches 78% LTV and meets the following conditions:
- Issued before June 3, 2013
- 30-year mortgages are eligible if borrowers have paid five years-worth (60 months) of mortgage premium payments
- 15-year mortgages do not have the same continuous mortgage premium payment requirement
Note: to determine the LTV, FHA uses the last known value of the home, typically the value at the time of purchase.
Loans endorsed by FHA after June 3, 2013, require carry mortgage insurance for the life of the loan. There is no automatic or borrower-initiated cancellation process. The only way cancel FHA mortgage insurance is to refinance the loan into another type of mortgage.
Here’s another small side note: for folks who have an older FHA loan and are looking to refinance, you may have the opportunity to do so with lower MIP rates. FHA loans endorsed on, or before, May 31, 2009 are “grandfathered” into lower MIP rates. (MIP premiums change from time to time and loans of a certain vintage get to use the older rates.) If you refinance from the existing FHA loan into a new FHA loan, you’ll get those lower MIP rates.
In most cases, the best way to get rid of FHA MIP is to refinance into a conventional mortgage and avoid FHA altogether. Why?
First, a few conventional programs allow high LTVs. That means you can refinance into a conventional loan well before you reach 80% LTV. Second, conventional loans have the automatic MIP cancellation trigger. You won’t have to refinance again in the future to cancel mortgage insurance. HomeReady and Conventional 97 are two programs that might work for you, based on your situation.
Getting Rid of the USDA Annual Fee
Just like FHA loans, USDA loans have an ongoing mortgage insurance premium called an annual fee. It is calculated each year, on the anniversary of the loan closing date. The calculation is made on the outstanding loan balance. Payments are broken up and paid monthly.
Another unfortunate similarity to FHA mortgage insurance is that the USDA annual fee stays with the loan for life. The only way to get rid of mortgage insurance is to refinance into another loan, preferably a conventional one.
Cancelling Mortgage Insurance FAQs
What are the major differences between Private Mortgage Insurance and Mortgage Insurance Premiums?
Private Mortgage Insurance (PMI) is:
- Used with conventional loans
- Not combined upfront mortgage insurance fees
- Insured by private companies
- Cancelled automatically or by request when certain conditions are met
Mortgage Insurance Premiums (MIP), also known as an Annual Fee with USDA loans, are:
- Used with government-backed loans
- Sometimes combined with upfront fees
- Insured by government agencies
- Usually not canceled automatically nor by request – most often, borrowers need to refinance a government-backed loan into a conventional loan
How much does it cost to refinance out of mortgage insurance?
The rule of thumb is that it costs 3% to 6% of the loan amount to refinance a mortgage. Borrowers can pay closing costs out-of-pocket or roll them into the new loan amount.
The option to roll them into the new loan depends on how extra equity headroom is available to accommodate the fees. After adding closing costs into the new loan amount, the LTV still needs to be 80% or less to cancel the mortgage insurance.
There’s another alternative: your lender to pay the closing costs, also known as a zero closing cost refinance. To make this happen, lenders charge a slightly higher interest rate.
What is the FHA MIP cancellation policy?
There are a few finer details described in the article above, but to understand MIP cancellation at a high level, just look at the date of origination. In general, loans originated before June 3, 2013, that reach 78% LTV will cancel MIP automatically. Loans originated after June 3, 2013, carry MIP for the life of the loan. These loans must be replaced (refinanced).
Can I cancel mortgage insurance by getting a VA loan?
Yes! In fact, if you are an honorably discharged veteran or active servicemember this is most likely the ideal route for you to take. VA loans have low interest rates and no annual insurance premiums. VA loans represent a great value to borrowers who’ve earned a VA guarantee.