If you’re considering using an FHA loan to buy a house, you’ve probably heard that they require mortgage insurance. You might also be wondering if FHA mortgage insurance can be removed once you’ve reached 20% equity in your home, as with a conventional (or non-government-backed) home loan.
The short answer is, it depends. If you make a down payment of 3.5%, like most borrowers who use FHA loans, you will probably have to pay annual mortgage insurance for the life of the loan. In this case, your FHA mortgage insurance cannot be removed, even when you reach 20% equity.
However, if you make a down payment of 10% or more when using an FHA loan, the annual mortgage insurance could be canceled after 11 years.
Note: The above rules apply to FHA purchase loans in particular (i.e., those used by home buyers). The “Streamline Refinance” program has its own set of rules, to be covered in a separate article.
Two Types of FHA Mortgage Insurance
Let’s start with the basics, before digging into the more detailed stuff.
FHA home loans are insured by the federal government, under the management of the Department of Housing and Urban Development (HUD). So it’s the federal government that determines all of the guidelines and requirements for this program.
One of their requirements is that borrowers who use an FHA loan must pay for mortgage insurance. In fact, there are two different premiums borrowers have to pay.
- The Upfront Mortgage Insurance Premium (UFMIP) equals 1.75% of the base loan amount. This is a one-time fee that, despite its name, can be rolled into the loan payments and paid over time.
- The Annual Mortgage Insurance Premium (MIP) can vary based on the terms of the loan. For most borrowers who use an FHA loan with a 3.5% down payment, the annual mortgage insurance premium comes to 0.85%.
And this is where things get a bit complicated. Some borrowers are able to cancel their annual FHA mortgage insurance after 11 years, while others are “stuck with it” for the life of the loan. The difference has to do with the amount of money you put down.
How the Down Payment and LTV Ties Into This
With a down payment of 10% or more, the loan-to-value (LTV) ratio is equal to or less than 90%. In this case, borrowers with an FHA loan could have their annual mortgage insurance canceled after 11 years.
With a down payment below 5%, the loan-to-value ratio ends up being greater than 95%. In this case, HUD requires borrowers to pay FHA annual mortgage insurance for the life of the loan.
The table below was copied from HUD Handbook 4000.1, the official guidelines for the FHA loan program. The table shows the annual MIP cancellation options (or lack thereof), based on the specific loan parameters.
It’s worth noting at this point that the majority of home buyers who use an FHA loan make a down payment below 5%. In fact, this is what attracts them to the program in the first place.
The FHA mortgage program allows borrowers to make a down payment as low as 3.5%. As a result, this program appeals to home buyers who have limited funds saved up for the initial upfront investment.
Because of this, most FHA borrowers make a down payment below 5%, which means they have an initial LTV ratio greater than 95%. As you can see from the table above, this means they would have to pay FHA annual mortgage insurance for the life of the loan (or the “mortgage term” in industry jargon).
Can It Be Canceled or Removed at 20% Equity?
You might’ve heard that some homeowners who have mortgage insurance can have it canceled once they reach 20% equity or ownership in their home. This is true, but it mostly applies to conventional mortgage loans.
The term “conventional” refers to a home loan that is not backed or guaranteed by the federal government. In other words, conventional and FHA mortgages are two different things entirely.
When using a conventional home loan, having an LTV ratio greater than 80% typically requires private mortgage insurance. But this is entirely different from the government-required mortgage insurance that applies to FHA loans.
Additionally, homeowners with a conventional mortgage can usually have their PMI policy canceled once they reach 20% equity in their home. Stated differently: They can cancel their mortgage insurance when the loan-to-value ratio drops to 80% or below.
According to the Consumer Financial Protection Bureau:
“You have the right to request that your servicer cancel PMI when you have reached the date when the principal balance of your mortgage is scheduled to fall to 80 percent of the original value of your home.”
But this 20% rule usually doesn’t apply to FHA loans. Whether or not you can cancel the annual mortgage insurance on an FHA loan has more to do with the size of your down payment, rather than the equity level you have in your home.
Of course, it’s possible to refinance out of an FHA loan and into a conventional mortgage at a later date. So that’s another way to get away from the FHA annual MIP expense. Just remember that conventional loans may also require mortgage insurance, particularly when the loan-to-value ratio rises above 80%.
Summary of Key Points
We covered a lot of information in this article. So let’s wrap up with a summary of the key takeaway points you should remember:
- Question: Can FHA mortgage insurance be removed at 20% equity?
- There are two kinds of mortgage insurance assigned to FHA loans — upfront and annual.
- The upfront premium (UFMIP) usually amounts to 1.75% of the base loan amount.
- The annual premium (MIP) for most borrowers who use FHA loans comes to 0.85%.
- But the annual MIP can vary, based on the down payment amount and the loan term or length.
- Borrowers who put down 10% or more can usually have their FHA MIP cancelled after 11 years.
- Borrowers who make a smaller down payment (below 5%) typically have to pay FHA annual mortgage insurance for the life of the loan.
Disclaimer: This article provides a basic overview of FHA mortgage insurance cancellation policies, based on official guidelines provided by the Department of Housing and Urban Development. Mortgage lending scenarios can vary from one borrower to the next. As a result, portions of this article might not apply to your situation. If you have questions or concerns about the subject, we encourage you to contact the FHA or speak to a HUD-approved mortgage lender. You can also refer to HUD Handbook 4000.1, which is available online.