A home buyer with less than a 20 percent down payment is usually required by his lender to pay for private mortgage insurance or PMI. The insurance reimburses the lender if the buyer defaults on the loan. When the buyer purchases a home with a loan insured by the Federal Housing Authority, or FHA, he pays a government-backed mortgage insurance premium. The premium makes for a higher mortgage payment. However, the FHA allows the buyer to discontinue this mortgage insurance once he has met certain conditions.
FHA Loan Overview
The FHA insures loans issued by approved lenders, assuring the lenders of repayment even if a borrower defaults. This assurance encourages lenders to issue more loans and to issue loans to buyers who may not qualify for conventional mortgages. FHA-insured loans appeal to creditworthy buyers of modest means because they have low down-payment requirements and credit guidelines that are easier for buyers to meet.
FHA Mortgage Insurance
A buyer who makes a low down payment has less equity, and thus less stake, in her home. Low equity increases the likelihood that she'll default on her loan. This, in turn, makes the loan risky for the lender. The FHA insurance mitigates the lender's risk. The mortgage insurance premium the buyer pays reimburses the FHA for the costs it incurs in insuring the loan on the lender's behalf. Buyers generally pay the mortgage insurance premium by making an upfront payment at closing and monthly payments thereafter.
The FHA will automatically cancel your mortgage insurance if you paid an upfront premium and have maintained a history of on-time mortgage payments. However, your loan must meet certain criteria. According to the U.S. Department of Housing and Urban Development, or HUD, if your loan has a term of more than 15 years it qualifies for cancellation once you’ve paid the mortgage insurance premium for at least five years and you've reached a 78 percent loan-to-value ratio -- in other words, you've paid off enough of your mortgage principal that the remaining balance equals no more than 78 percent of your home's value. A loan with a term of 15 years or less or that had initial loan-to-value ratio of 90 percent or more -- meaning you made a down payment of 10 percent or less -- qualifies once the loan-to-value ratio reaches 78 percent no matter how long you've paid the premium. The FHA doesn't require mortgage insurance when a buyer makes a down payment of greater than 10 percent and has a loan term of fewer than 15 years.
According to HUD, if you originated your FHA loan after September 1, 1983, and paid an upfront premium at closing -- and you have not defaulted on your loan -- you may be entitled to a refund of some of your mortgage insurance premium. You may be entitled to a share of excess earnings from a special mortgage insurance fund if you originated your loan after Sept. 1, 1983, made payments for more than seven years and had your insurance terminated before Nov. 5, 1990. Borrowers with assumed FHA loans are not eligible for refunds. However, if you're due a refund and you refinance your FHA loan, you may apply your refund to the new loan's upfront premium. You'll apply for any refund you're due after your lender informs the FHA that your mortgage insurance has been canceled.