If you bought your home using an FHA loan, you are paying mortgage insurance (MI) each month. MI limits the lender’s exposure to loss if a borrower fails to make their payments and the lender has to foreclose on the property.
The amount you pay depends primarily on when you got your loan. The premium was just .55% up until October, 2010, when FHA raised it to .90%. The MI increased each year until April, 2013, when it reached 1.35%. FHA decreased it to .85% in January, 2015. Even though the premium increased, it did so only for new loans; existing loans continued at the rate when they were originated.
Mortgage insurance is expensive
The monthly premium is costly; a homeowner who paid $400,000 for his home in 2012 and made a 3.5% down payment would fork over more than $400 a month for MI.
If you have an FHA loan, there is good news and bad news. The good news is that you may be able to get rid of that expensive mortgage insurance. The bad news is that if you got your loan after June, 2013, you’re stuck with it for the life of the loan, which is until you sell the home, pay it off, or refinance.
Can you drop your mortgage insurance?
For loans originating prior to June, 2013, FHA allows you to drop MI once the loan balance reaches 78% of the original purchase price of the property. If your rate is 3.5%, you’ll reach that balance in slightly less than 10 years.
You can drop the insurance as early as 60 months, however, by reducing your loan balance to 78%. This would mean coming up with cash. How much? If you paid $400,000 for your home and made a 3.5% down payment, you’d have to reduce the balance to $306,000. If you’ve had your loan for 3 years, your balance would be $369,000. That means coming up with more than $60,000 cash.
If you don’t have an extra 60 grand lying around, there may still be hope. Since your home is probably worth quite a bit more than when you bought it, you should consider getting a Home Equity Line Of Credit (HELOC) to generate cash. You would be able to drop the $400 a month MI payment, but have a small payment on the HELOC—probably around $200 a month or less.
If you got your loan after June, 2013, you may still be able to get rid of your MI—but you would do so by refinancing into a conventional loan. You may discover that the rate on a new conventional loan is a bit higher than what you have now, but without the costly burden of mortgage insurance.
What you should do now
- Remember all those documents you signed when you bought your home? Dig them out and find the closing statement. This will tell you what you paid for your home and the date you closed escrow. If you closed escrow before June, 2013, go to the next step.
- Multiply the purchase price by 78%. That will tell you the point at which you can drop the MI—but remember: you can’t drop it earlier than 60 months.
- Next, look at your most recent mortgage statement to find the loan balance. The difference between the 78% figure you calculated and the current balance is the amount you would reduce your balance to eliminate MI.
- Finally, get some idea of your home’s value. This will tell you whether you have enough equity to get a HELOC to pay down your mortgage to the 78% level. Your total financing should not exceed 80% of the current value.
If you have a newer FHA loan
If you have a loan where you can’t drop the MI, you should look into refinancing into a conventional loan. Although your FHA note rate may be lower than today’s conventional loans, you have to take the permanent mortgage insurance into account. Even if you have a note rate of 3.5%, FHA MI of 1.35% gives you an effective rate of 4.85%. With conventional rates well below 4% today, there is plenty of room to improve your position.
Some things to watch
Until very recently, there was a quirk in FHA loans that allowed lenders to collect a full month’s interest when the loan is paid—even if you pay them off on the first of the month. If you are refinancing into a conventional loan, plan to close at the end of the month to avoid paying this extra interest.
If your home hasn’t appreciated enough to give you an 80% loan to value ratio, there is still hope. If your new loan is more than 80% of the home’s appraised value, you will have to pay private mortgage insurance (PMI). PMI is different in that it should be far less costly than the FHA MI you have been paying and—most important—you CAN drop PMI once you can show that the present value of your property gives you an 80% loan to value ratio.
If you’ve decided that a refinance may still be the best way to get clear of FHA mortgage insurance, it’s time to talk with an experienced loan officer. To learn more on your own about refinancing a home, click the button below to download our exclusive ebook.