A borrower needs to pay mortgage insurance premium (MIP), if he buys home with an FHA mortgage and puts down less than 20% of the purchase price. But is it possible to avoid paying MIP, even though you’re making less than 20% down payment?
Well, one of the posters in MortgageFit forums has a similar query. He intends to make a down payment of 3.5%-5% on an FHA loan to buy a home for $320,000. But he says the house is appraised by the lender at $410,000. He asks:
Can he remove the MIP since there’s enough equity in the home?
FHA requires a borrower to pay an upfront mortgage insurance premium of 1.75% and an annual premium of 0.55%, if he makes less than 20% down payment. The MIP can be canceled when the loan-to-value (LTV) ratio of the property reaches 78% of the original home value. However, the payment of MIP for the first 5 years is mandatory for FHA loans with terms of more than 15 years. Thus, if the poster is going for, say, a 30 year FHA mortgage, he’ll not be able to remove the MIP within the first 5 years, even though the LTV is 78% or lower.
However, if the poster goes for a 15 year FHA mortgage and makes a down payment of 10% or more, he can cancel the MIP once the loan balance is 78% of the actual sales price. He does not have to wait for the first 5 years to eliminate the MIP.
Can he avoid mortgage insurance on a conventional loan?
Conventional loans also require a borrower to pay mortgage insurance, known as private mortgage insurance (PMI). Conventional mortgage lenders are required by law to drop off the mortgage insurance once the LTV reaches 78%, provided the borrower is current on the loan. But different lenders have different requirements to remove the mortgage insurance. Most of them want the borrower to live in the property for at least the first 2 years before they can remove the PMI.
Moreover, the PMI is calculated based on the sales price or the appraised value of the property, whichever is less. Thus, if the home is currently appraised at $410,000 and the poster is buying the property for $320,000, the PMI will be based on the sale price. So, if the poster cannot make a down payment of 20% of the sale price ($320,000), he will have to pay the mortgage insurance. The high appraised value of the property at the time of the purchase will not help him much in this situation.
Thus, the poster will have to pay the mortgage insurance on an FHA loan for at least the first 5 years and for the first 2 (or more) years on a conventional loan. The only loan programs that do not require any mortgage insurance premium are USDA and VA loans, though both of them do require guarantee fee and funding fee, respectively.
To view the discussion, you can refer to the following page:
http://www.mortgagefit.com/homeloan/pmi-fha-equity.html