Mortgage insurance is a common way for lenders to minimize risk and protect themselves from borrower defaults on home loans. This insurance also works to the borrower’s benefit by helping ensure that they can meet the terms of their mortgage. Different types of loans have slightly different types of mortgage insurance premiums. Those for government-backed loans, including home equity conversion mortgages (HECMs), are called MIPs. Here’s an explanation of mortgage insurance premiums and how they work.
What Is Mortgage Insurance?
Mortgage insurance ensures borrowers don’t default on their mortgages. By lowering the lender’s risk, mortgage insurance allows the borrower to qualify for a mortgage that may otherwise be out of reach.
While mortgage insurance makes it possible for the borrower to get the loan, it also increases the cost of the loan. The most common way to pay mortgage insurance is a monthly payment. However, the way mortgage insurance gets paid is determined by the lender and the type of loan. Some lenders require an upfront premium at closing, others may require a combination of monthly payments and an upfront premium. Some types of loans, like HECMs, also specify how borrowers pay their premiums.
A premium is a monthly insurance payment. There are two types of mortgage insurance premiums.
- Private mortgage insurance payments (PMI). The name of premiums for a conventional loan.
- Mortgage insurance premiums (MIP). The name of premiums for government-backed loans.
Understanding Private Mortgage Insurance in Conventional Loans
Private mortgage insurance applies to conventional loans, which are not backed by the government and are made through private lenders. Lenders require PMI when the down payment is less than 20%. The PMI premium depends on the size of the loan and the down payment. It is usually 0.5% or 1% of the loan.
Understanding Mortgage Insurance Premiums in FHA-Insured Loans
Federal Housing Administration (FHA) loans also require mortgage insurance. Loans insured by the FHA allow borrowers to get loans with a down payment as low as 3.5% of the purchase price and a credit score of 580.
FHA loans require a borrower to pay two premiums: (1) a one-time upfront premium of 1.75% of the loan amount; and (2) an annual premium that can vary from 0.45% to 1.05% depending on factors such as the size, term and loan-to-value ratio of the loan.
The FHA typically uses key factors and a formula to calculate the upfront and annual premium. The upfront premium is a one-time fee usually paid at closing. Borrowers can either roll the cost into the loan and add it to the base loan amount or pay it up front.
It is worth noting that mortgage insurance for conventional FHA mortgages offers fewer consumer protections than mortgage insurance on FHA-insured reverse mortgages.
Reverse Mortgages and Mortgage Insurance Premiums
All borrowers who obtain a home equity conversion mortgage (HECM) pay an upfront and annual MIP.
The upfront reverse mortgage MIP will likely be included in the closing costs and other fees associated with the loan. For a HECM, the upfront mortgage insurance premium will be 2% of the lesser of the home value or the maximum lending limit.
A HECM will require an annual ongoing MIP during the life of the reverse mortgage. For a HECM, the annual MIP is 0.5% annually. For instance, if the outstanding balance on the loan is $150,000, the yearly insurance cost is $750. The MIP is added to the loan balance monthly (divided by 12), but the outstanding loan balance also increases every month, unless the borrower chooses to make a payment.
The Value of Reverse Mortgage MIP to Borrowers
While a reverse MIP does add to the cost of a reverse mortgage, it’s not an empty fee and borrowers receive multiple benefits in exchange.
Higher Risk Borrowers Get Access to Loans
The existence of an FHA mortgage insurance fund allows higher-risk borrowers to benefit from a HECM. Without the fund guaranteeing their mortgages in case of default, lenders would be less willing to accept the risk that comes from extending reverse mortgages to people with low credit scores, or other financial issues.
MIP Allows HECMs to Be Nonrecourse
The same protections that lenders receive from mortgage insurance also apply to reverse mortgage borrowers. FHA-provided mortgage insurance allows HECMs to be nonrecourse, meaning borrowers or their heirs will never be responsible for paying back more than the market value of the home at the time the loan comes due. In other words, even if the home is underwater or worth less than the mortgage, the lender cannot take more than the sale price of the home to satisfy the mortgage.
MIP Allows HUD to Guarantee HECMs
HECM borrowers mortgage payouts and lines of credit are also protected by their MIP. Should the lender go out of business, the mortgage insurance will allow borrower payouts to continue and keep their line of credit open.
Canceling Mortgage Insurance Premiums
As time passes and borrowers make regular mortgage payments, some homeowners may wish to cancel mortgage insurance premiums. For FHA loans, cancellation isn’t possible for every borrower and depends on the loan’s origination date.
- Loans originated between December 31, 2000, to July 3, 2013. If the borrower has paid off at least 78% of the loan-to-value ratio amount, borrowers can request to cancel MIP.
- For loans originated after July 3, 2013. If the borrower made only a down payment that is less than 10% of the home’s value at loan origination, the lender would not cancel MIP payments. The borrower can remove a MIP only if the FHA loan is refinanced into a non-government-backed product.
Unlike a PMI in a conventional mortgage, reverse mortgage borrowers cannot cancel reverse mortgage insurance. The only way to eliminate annual MIP is for the borrower to pay off the loan.
Taxes and Mortgage Insurance Premiums
Paying insurance premiums every month increases the cost of homeownership. However, Congress tries to relieve that burden by allowing some homeowners to deduct these payments from their taxes.
To qualify for the deduction as of 2021, the borrower’s total adjusted gross income had to be less than $54,000 for single filers and $109,000 for joint filers. Lenders must send a Form 1098 Mortgage Interest Statement to the borrower and the Internal Revenue Service (IRS). This form lists the mortgage insurance payments.
In 2021, this deduction was set to expire, but the Consolidated Appropriations Act extended it through the year. Unfortunately, the 2023 Consolidated Appropriations act of 2023 did not extend the deduction. However, two congressmen have introduced a bill that would make the deduction permanent.
This article is intended for general informational and educational purposes only, and should not be construed as financial or tax advice. For more information about whether a reverse mortgage may be right for you, you should consult an independent financial advisor. For tax advice, please consult a tax professional.