What is PMI on a Mortgage? Here’s What You Need to Know for FHA Loans

If you're in the process of buying a home, you’ve likely come across the term Private Mortgage Insurance (PMI). It’s one of those extra costs that often comes as a surprise, especially if you’re not putting down 20% upfront. PMI can be required for conventional loans, but for FHA loans, it’s a bit different. FHA loans come with their own type of mortgage insurance called Mortgage Insurance Premium (MIP). In this guide, we’ll help you understand what MIP is, why it’s required, and, most importantly, how you can eventually get rid of it.

Let’s take a look at Lisa, who’s considering buying a home with an FHA loan and wants to understand how MIP works and what her options are for removing it down the line.

What is Mortgage Insurance Premium (MIP) for FHA Loans?

Unlike conventional loans that require PMI when you put down less than 20%, FHA loans come with Mortgage Insurance Premium (MIP). This type of insurance protects the lender in case you default on the loan. MIP is required for FHA loans, regardless of how much you put down, though the length of time you have to pay it depends on your down payment.

Meet Lisa
Lisa is thinking about buying her first home using an FHA loan. She has saved enough for a 3.5% down payment, which makes her eligible for the FHA loan program. However, because her down payment is less than 20%, she knows she’ll have to pay MIP. But Lisa is curious—how long will she have to keep paying it, and is there a way to get rid of it eventually?

How MIP Works and What It Costs

MIP comes in two parts: an upfront premium and an annual premium. Let’s break it down:

• Upfront MIP: When Lisa gets her FHA loan, she will need to pay an upfront MIP premium of 1.75% of the loan amount. This can be rolled into the loan if she doesn’t want to pay it out of pocket at closing.

• Annual MIP: In addition to the upfront premium, Lisa will also have to pay an annual MIP, which is broken into monthly payments. For most FHA loans, this amount ranges from 0.45% to 1.05% of the loan amount per year, depending on the loan size, loan-to-value ratio, and length of the loan.

Let’s say Lisa buys a $250,000 home with a 3.5% down payment. Her upfront MIP would be $4,375. For her annual MIP, she’d be paying about $175 to $218 per month, depending on her loan terms.

How Long Does Lisa Have to Pay MIP?

One of the key differences between conventional loans and FHA loans is that MIP can last much longer than PMI. For FHA loans, how long you pay MIP depends on your down payment:

• If Lisa puts down less than 10% (as in her case, 3.5%), she will have to pay MIP for the life of the loan.

• If she manages to put down 10% or more, she will only have to pay MIP for 11 years.

Unfortunately for Lisa, with her 3.5% down payment, MIP will be required for the entire duration of her 30-year loan unless she takes action to remove it.

How to Avoid PMI on a Mortgage

The most straightforward way to avoid PMI is to make a down payment of 20% or more. But what if, like Lisa, that isn’t feasible right now? There are a few other options:

1. Consider an FHA Loan: If Lisa qualifies, an FHA loan could be a great option. These loans have lower down payment requirements (as low as 3.5%), and while they come with mortgage insurance, the terms may be more favorable for those with lower down payments.

2. Look into a USDA Loan: If Lisa is purchasing in a qualifying rural area, a USDA loan might be available. These loans often have zero down payment requirements and may not require PMI, though they come with their own set of fees and requirements.

3. 203K Renovation Loan: If Lisa is looking to buy a home that needs repairs or renovations, a 203K Renovation Loan could help her finance both the purchase and the improvements. These loans come with mortgage insurance, but they may offer a path toward lower initial costs.

Budget for your 20% down payment

How to Get Rid of MIP

Let’s say Lisa decides to go ahead with her 3.5% down payment. Now, how can she ditch that MIP as soon as possible? Here are the main ways:

1. Refinance into a Conventional Loan: The most common way to remove MIP from an FHA loan is to refinance into a conventional loan. Once Lisa has built up at least 20% equity in her home, she could refinance into a conventional mortgage, which doesn’t require PMI if you have at least 20% equity. This means Lisa could stop paying MIP altogether by refinancing once her home’s value increases or she pays down her loan enough.

   • Tip: Lisa should keep an eye on both her home’s value and her loan balance. If home prices in her area rise significantly, she might be able to refinance sooner than expected.

2. Pay Down the Loan Faster: If Lisa wants to speed up the process, she can make extra payments toward her principal to build equity faster. This won’t automatically remove MIP, but it will help her reach that 20% equity mark sooner, making refinancing a more viable option.

3. Monitor Home Value Increases: Lisa might be able to take advantage of rising home prices. If the market value of her home increases significantly, she could reach the 20% equity threshold faster and refinance out of the FHA loan. However, this would likely require paying for a home appraisal to prove the increase in value.

Is Refinancing Always the Best Option?

While refinancing is the most common way to remove MIP, it isn’t always the best choice for everyone. Refinancing comes with its own costs, such as closing fees and possible changes in interest rates. Lisa should weigh these costs against the savings from not having to pay MIP.

For example, if interest rates have risen significantly since Lisa took out her FHA loan, it may not make financial sense to refinance, even if she can avoid MIP. In that case, continuing to pay MIP might be the best option, especially if the monthly cost of MIP isn’t breaking the bank.

Financial Impact of MIP

MIP can add up over time, especially if Lisa has to pay it for the life of the loan. Let’s break it down:

If Lisa buys a $250,000 home and pays approximately $200 a month in MIP, that’s an extra $2,400 a year. Over the life of a 30-year loan, that’s $72,000—just in MIP. Refinancing, when possible, could save Lisa a significant amount of money in the long run.

Should You Consider an FHA Loan with MIP?

For many first-time homebuyers like Lisa, FHA loans are an excellent option. They offer lower down payments and more flexible credit requirements. However, the trade-off is the cost of MIP, which can add to your monthly mortgage payments and last for the life of the loan.

Lisa is weighing whether to continue saving for a larger down payment to avoid MIP or move forward with the FHA loan. Given her financial situation and the rising cost of homes in her area, she’s leaning toward getting the FHA loan now, knowing she can refinance later to remove MIP when her equity reaches 20%.

So, What is PMI on a Mortgage?

MIP is a necessary part of FHA loans, especially for buyers who don’t have a 20% down payment. While it can be frustrating to have to pay mortgage insurance for the life of the loan, there are ways to get rid of it, primarily through refinancing into a conventional loan once you’ve built up enough equity. Lisa, like many first-time homebuyers, has options. By understanding how MIP works and planning ahead, she can make a smart decision about her home purchase and take steps to eliminate MIP when the time is right.

If you’re considering an FHA loan and want to learn more about your mortgage insurance options or refinancing opportunities, reach out to First Alliance Credit Union. We’re here to help you navigate the homebuying process and make the best financial decisions for your future.

Have more questions? Ask us!