How to Successfully Drop PMI on an FHA Loan in 2023

Private mortgage insurance (PMI) is an extra cost required by most lenders when your down payment is less than 20% of the purchase price. With an FHA loan this insurance is called mortgage insurance premiums (MIP) and is required on all loans. Many borrowers want to know how to get rid of PMI on an FHA loan to save money each month.

Dropping PMI on an FHA loan used to be straightforward – once you reached 78% loan-to-value ratio, PMI would automatically drop off However, FHA guidelines changed in 2013, making it much harder to remove PMI Now, you either need to refinance out of your FHA loan, make a large down payment upfront, or wait 11 years before PMI drops off.

In this article, I’ll explain exactly how FHA PMI works, when it can be removed, and your options for dropping it through refinancing to a conventional loan.

How Does FHA PMI Work?

With an FHA loan, you’ll pay two types of mortgage insurance premiums:

• Upfront MIP: A 1.75% fee paid at closing, based on the total loan amount. On a $200,000 loan, this equals $3,500.

• Annual MIP: An annual fee paid monthly along with your mortgage payment. This is 0.85% of your loan amount for loans with under 10% downpayment. On a $200,000 loan balance, you’d pay $167 per month.

Annual MIP lasts for the life of your FHA loan. Previously it could be dropped once hitting 78% loan-to-value ratio. But for most modern FHA loans you’ll pay this monthly fee until you refinance or pay off the loan.

The only way to remove annual MIP earlier is:

• Put at least 10% down – PMI will drop off after 11 years
• Refinance into a conventional loan

Next, let’s look at both of these options in more detail.

Remove PMI by Putting 10% Down

If you make a down payment of at least 10% of the purchase price, your annual MIP will automatically terminate after 11 years of payments.

For example, if you purchase a $200,000 home and put down $20,000 (10%), you’ll pay annual MIP for 11 years before it drops off. This would save you over $18,000 in mortgage insurance over the life of a 30-year FHA loan.

The downside is that few buyers have 10% to put down these days. Coming up with 3.5% down is difficult enough for many. But if you can pay at least 10% down, it’s one route to eventually dropping PMI.

Refinancing to a Conventional Loan

The most common way borrowers remove PMI from an FHA loan is to refinance to a conventional loan. Here are some key points on doing this:

• You’ll likely need 20% equity in your home to qualify for a conventional refinance.
• Conventional loans allow PMI removal at 78% LTV.
• Refinancing costs money – you’ll pay closing costs equal to 2-5% of the loan amount.
• Your new interest rate may be higher than your existing FHA rate. Do the math to see if dropping PMI will save you money long-term.

To refinance, you’ll go through an entirely new mortgage application process, including credit check, income verification, appraisal, and underwriting. It’s like taking out a new purchase loan on your home.

But by moving to a conventional loan, you can take advantage of much more lenient PMI cancellation policies.

Here are some strategies for refinancing to remove PMI:

1. Cash-out Refinance

If your home value has increased significantly, you may be able to do a cash-out refinance to get to 20% equity. You take out more than you currently owe, pulling cash out of the increased equity while keeping a 20% stake in the home.

This avoids PMI on the new loan while freeing up money from your equity. Just know that cash-out refis have higher rates.

2. Rate/Term Refinance

If you don’t want to tap equity, you can do a rate/term refinance for the exact payoff amount of your current mortgage. As long as you have 20% equity, this will get you a new conventional loan without PMI.

Focus on finding the lowest rate possible to make sure you save long-term by dropping PMI.

3. FHA Streamline Refi

FHA streamline refinancing lets you refinance into a new FHA loan with only minor closing costs. If your credit and income have improved since getting your original FHA mortgage, this can help you qualify for a better rate.

You can then refinance again later to a conventional loan once you’ve built up 20% equity.

When Can PMI Be Removed from FHA Loans?

Let’s summarize when MIP can come off an FHA loan:

For loans closed before June 3, 2013:

• PMI automatically terminates once reaching 78% LTV

For loans closed after June 3, 2013:

• PMI drops off after 11 years if you put at least 10% down
• PMI lasts for the life of the loan with less than 10% down

Unless you make a sizable down payment upfront, you’ll need to refinance to remove PMI from a modern FHA loan. Conventional mortgages allow cancellation at 78% LTV or by request at 80% LTV.

Is Conventional PMI Cheaper Than FHA MIP?

Whether conventional PMI or FHA MIP costs less depends entirely on your specific loan terms and credit profile. Here are some key differences:

• FHA MIP is set by the FHA based on your loan-to-value ratio and term. Conventional PMI rates vary by lender.

• FHA MIP lasts for the life of the loan unless you put 10% down or refinance. Conventional PMI goes away at 78% LTV automatically.

• Conventional PMI is based on your credit score. FHA MIP is not.

For borrowers with lower credit scores, FHA loans can provide access to low down payment mortgages with average rates. But you pay for this access through high monthly mortgage insurance.

Carefully compare options from both FHA and conventional lenders. For many borrowers, FHA provides the better value and easier path to homeownership. But for some, conventional PMI may be cheaper.

Alternatives to Paying PMI

If you want to avoid mortgage insurance but can’t afford a 20% down payment, here are two alternatives to explore:

1. 80/10/10 Piggyback Loan

This combines a first mortgage for 80% of the value along with a second mortgage (“piggyback loan”) for 10%, avoiding PMI on the main mortgage.

2. Lender-Paid PMI

The lender pays your PMI in exchange for a slightly higher interest rate on the mortgage. You avoid the monthly PMI payment but pay more in overall interest.

The Bottom Line

Removing PMI from an FHA loan is certainly possible, but isn’t as simple as it once was. If you have the means to make a 10% down payment, this will eventually result in PMI dropping off after 11 years of payments.

But most buyers looking at FHA loans don’t have that much for a down payment. In that case, your best route to dropping MIP is to refinance to a conventional loan. Once you’ve built up 20% home equity, you can take advantage of more lenient guidelines for cancelling PMI.