What Is Mortgage Insurance Premium (MIP)?
Mortgage insurance premium (MIP) is paid by homeowners who take out loans backed by the Federal Housing Administration (FHA). Until the 2017 Tax Cut and Jobs Act, mortgage insurance premiums were deductible in addition to allowable mortgage interest. However, the Further Consolidated Appropriations Act of 2020 allows tax deductions for MIP and private mortgage insurance (PMI) for 2020 and retroactively for 2018 and 2019.
- Mortgage insurance premium (MIP) is paid by homeowners who take out loans backed by the Federal Housing Administration (FHA).
- FHA-backed lenders use MIPs to protect themselves against higher-risk borrowers who are more likely to default on loans.
- FHA mortgages require every borrower to have mortgage insurance.
Understanding Mortgage Insurance Premium (MIP)
FHA-backed lenders use mortgage insurance premiums (MIP) as a tool to protect themselves against higher-risk borrowers. Since FHA loans come with a down payment as low as 3.5% with a credit score as low as 580, default is a key concern.
FHA mortgages require every borrower to have mortgage insurance. Conversely, conventional loans only need private mortgage insurance (PMI) policies if the down payment amount is less than 20% of the property's purchase price. Each FHA loan requires both an upfront premium of 1.75% of the loan amount and an annual premium of 0.45% to 1.05%. Payment of upfront premiums is at the loan issuance. Determination of the exact yearly cost comes from the term of the loan, amount borrowed, and loan-to-value ratio.
Each month, the loan's payment amount will reflect the annual premium divided by 12 months along with the principal payment. Other charges usually added to the monthly fee include escrow amounts for property taxes and homeowner's insurance coverage.
Canceling Qualified Mortgage Insurance
Using a conventional loan, the buyer may cancel the PMI once they pay 20% of the loan's value or after the loan is 11 years old. However, the FHA may not allow you to take this reduction. It depends on the origination date of the loan.
- For loans originated between December 31, 2000, and July 3, 2013, if you have paid at least 78% of the loan-to-value (LTV) amount off, you may ask the lender to cancel the MIP.
- For loans originated after July 3, 2013, if you made a down payment of less than 10% of the home's value at loan origination, you must pay the MIP for the life of the loan. The only way to remove the qualified mortgage insurance (MIP) on an FHA loan is to refinance it into a non-FHA product.
Borrowers who qualify for a conventional loan, even if they will pay private mortgage insurance, should also look at FHA loans to determine which is the better deal. Those with lower credit scores may do better with an FHA mortgage, particularly if they can make a 10% down payment. Also, some lenders may provide a separate loan to cover the down payment amount. Be sure to talk to your tax accountant, financial advisor, and your bank to see which loan makes the most sense for your situation.
Tax Implications of Qualified Mortgage Insurance Premiums
Every year, your lender is required to send Form 1098 Mortgage Interest Statement to both you and the Internal Revenue Service (IRS). This form lists your mortgage payments over the past year and can affect your income tax. The total amount of the MIP or PMI premiums will be in box 5 of the form. To claim a deduction for either type of mortgage insurance, you must itemize your deductions using Schedule A under the interest paid section.
The deduction for these premiums expired on Dec. 31, 2017, thanks to the passage of the Tax Cuts and Jobs Act of 2017. However, the Further Consolidated Appropriations Act, 2020 passed, and Congress extended the deduction through Dec. 31, 2020. That means that the deduction was available for the 2019 and 2020 tax years, and retroactively for 2018 taxes.
Not everyone can take advantage of the deduction for qualified mortgage insurance premiums (MIP). Whether you qualify depends on both your filing status and adjusted gross income (AGI). The deduction reduces by 10% for every step over the allowable borrower's AGI limit. It disappears entirely for those earning over $54,500, or $109,000 for joint filers.