What is a mortgage insurance premium (MIP)?
Most home purchases are financed to some degree, but homebuyers still need to put down a sizable amount of money up front. Many people hold off on buying a house because they’re waiting to save up enough funds to cover those initial costs.
You may have heard that you need at least a 20% down payment to avoid paying mortgage insurance. You may have even been told that a mortgage insurance premium (MIP) — like the kind required with any FHA loan — was something to avoid at all costs. But is that really true?
When mortgage insurance stands in your way of becoming a homeowner and investing in real estate, avoiding it may be more harmful to your long-term financial situation. The truth is, MIP has gotten a bit of a bad rap, but we’re going to clear the air.
MIP explained: How mortgage insurance premiums work
Borrowers pay mortgage insurance premiums on home loans insured by the Federal Housing Administration (FHA). Because FHA financing accepts down payment options as low as 3.5% of the loan amount, additional mortgage insurance is applied to all FHA loans. Mortgage insurance protects lenders from borrowers who default on their FHA home loans. Paying MIP at the outset of the loan helps soften some of that risk.
You can expect the initial MIP, which is due at closing, to reflect 1.75% of your home’s purchase price. MIP will also be built into your monthly mortgage payments along with the principal, interest, homeowners insurance and property taxes.
MIP vs. PMI: What’s the difference?
There are so many acronyms in the world of mortgage lending that it can sometimes feel like you’re wading through alphabet soup. In particular, the differences between MIP and PMI — private mortgage insurance — can cause a lot of confusion, especially given their close similarities. Let’s put any misunderstandings about these two terms to rest.
- MIP: An upfront payment you make — plus an annual premium — when you take out an FHA loan. The upfront mortgage insurance premium is sometimes referred to as UFMIP, while the ongoing monthly premium is called MIP.
- PMI: Insurance you pay each month on a conventional mortgage until you’ve gained 20% equity in your home.
Both MIP and PMI serve the same basic function — mitigate investments for lenders — but they’re applied in different scenarios. If you use a traditional type of home loan, like a 15-year fixed rate mortgage, and are unable to put up 20% for the down payment, you’ll need to pay PMI. Taking out an FHA loan? Then you’ll be paying for MIP.
Another big difference between the two is that borrowers may wind up paying MIP for a much longer time. FHA loans may require mortgage insurance premiums for more than a decade — possibly throughout the entire life of the loan. With PMI, borrowers only have to pay for mortgage insurance until they’ve hit the 20% equity threshold. That being said, FHA loan borrowers could potentially refinance their mortgage at a later time to use a different type of home loan that doesn’t require MIP.
Is MIP tax-deductible?
In some cases, homebuyers can deduct the cost of mortgage insurance, including both MIP and PMI, from their taxable income. Although those deductions were set to expire, the 2021 Consolidated Appropriations Act extended certain MIP deductions through the 2021 tax year. To qualify for these deductions, your household’s adjusted gross income must be less than $109,000 a year. While that may prevent some homeowners from taking advantage of these perks, borrowers with FHA home loans are more likely to fit that criteria.*
Reducing your taxable income can put more money back in your pocket, and honestly, every little bit helps. With inflation creeping up, credit card rates increasing and wages appearing to remain flat, budgets may feel stretched just covering the bare necessities. That’s to say nothing of the self-care expenditures — like treating ourselves to a meal at a nice restaurant, watching the latest blockbuster or going to a concert — that we all deserve from time to time.
Should you avoid MIP?
Prevailing wisdom would say that borrowers should do everything possible to avoid paying for mortgage insurance. After all, the money you spend on those payments won’t build equity in your home. The extra cost of MIP might deter people from taking out an FHA loan to buy a house, instead waiting until their finances are in a position to support a conventional mortgage.
But there’s an argument to be made that paying a mortgage insurance premium can be worth the cost to start building wealth through real estate right away. Many homeowners use their house as an investment vehicle, expecting the value of their property to go up over the course of the next 15-30 years. Real estate purchases can also protect homeowners against inflation if you lock in a mortgage rate that will decline in monetary value during that same time period.
Let’s say you pay $1200 a month for the principal and interest on a 30-year fixed rate mortgage. In 10 or 20 years, that same $1200 will be worth significantly less than it does today. So, in essence, you’ll wind up paying less on your monthly housing costs down the road, even though the dollar figure will stay the same. Compare that situation with renting an apartment, where your monthly rent will likely increase each year to keep up with inflation and real estate market trends.
Keep in mind that inflation jumped 4.2% in April 2021 alone, according to the U.S. Department of Labor. Inflation hasn’t gone up that much in a single month since September 2008. Although no one can say for certain how inflation rates will change in the coming years, the buying power of the U.S. dollar has steadily depreciated since the Federal Reserve System was created in 1913.
With so much uncertainty surrounding future inflation fluctuations, you may not want to put off buying a house if you’re interested in building equity in your home as soon as possible. Waiting until you have enough money to make a large down payment could cost you more in the long run.
Lowering (or removing) mortgage insurance premiums
Although you shouldn’t necessarily let MIP dissuade you from pursuing homeownership, it’s always a good idea to look for ways to lower those costs — if not eliminate them entirely. Because mortgage insurance premiums often last the entire length of an FHA loan, the only surefire way to reduce these housing costs is to refinance. If you’re tired of paying MIP, speak with a mortgage lending expert to see what loan options are available. Depending on your financial situation and the status of your FHA loan, you may be able to refinance your mortgage and swap it for a conventional home loan that doesn’t require MIP.
Refinancing could also help you take advantage of lower premiums if MIP rates have dropped since you first took out your mortgage. Since mortgage insurance premiums change from year to year, today’s rates could be lower than what you’re currently paying. You might still have an FHA loan after refinancing, but you could reduce your monthly housing costs in the process. In either case, be sure to consult a qualified loan officer or lending professional who can provide expert guidance.
Borrowers pay a mortgage insurance premium when using an FHA home loan. In addition to an upfront payment totaling 1.75% of the home purchase price, you also need to cover the cost of annual premiums with your MIP.
Although prospective homeowners are often discouraged from financing that requires mortgage insurance, market conditions can sometimes make the tradeoff worth the extra cost. In particular, when rising inflation and flat wage growth inhibit your buying power, it may make sense to lock in a home loan that will likely decrease in value over time.
Remember, using your home as a potential investment vehicle carries inherent risk. Never agree to financing terms you’re not comfortable sticking to for the long haul. At the very least, speak to a qualified loan officer who can discuss your loan options and how they might impact your future financial situation.