Federal Housing Administration-backed loan borrowers pay mortgage insurance premium (MIP) (FHA). Prior to the Tax Cuts and Jobs Act of 2017, mortgage insurance premiums were deductible alongside mortgage interest. Nevertheless, the Further Consolidated Appropriations Act of 2020 permits tax deductions for MIP and private mortgage insurance (PMI) for 2020, as well as retroactively for 2018 and 2019.

What Is Mortgage Insurance Premium (MIP)?

• Mortgage insurance premium (MIP) is paid by homeowners who obtain Federal Housing Administration-backed loans (FHA).

• FHA-backed lenders use MIPs to protect themselves from the higher-risk borrowers who are more likely to default on loans.

• FHA mortgages require mortgage insurance for all borrowers.

Understanding About Mortgage Insurance Premium (MIP)

FHA-backed lenders utilize mortgage insurance premiums (MIP) as a means of protection against borrowers with a higher risk profile. Since FHA loans require as little as a 3.5% down payment with a credit score as low as 580, default is a major concern.

Every FHA borrower is required to carry mortgage insurance. In contrast, conventional loans only require private mortgage insurance (PMI) if the down payment is less than 20% of the purchase price. Each FHA loan always requires an upfront premium of 1.75 percent of the loan amount and an annual premium ranging from 0.45 percent to one percent. The upfront premiums are paid when the loan is issued. The exact annual cost is determined by the loan's term, borrowed amount, and loan-to-value ratio.

In addition to the principal payment, the monthly loan payment will reflect the annual premium divided by 12 months. Escrow amounts for property taxes and homeowner's insurance coverage are typically added to the monthly payment.

If you make a down payment with less than 20% on a conventional Fannie Mae or Freddie Mac mortgage, you will likely be required to pay private mortgage insurance (PMI) on a monthly basis until you accumulate at least 20% equity in your home. PMI provides an alternative form of loan guarantees for USDA rural mortgages.

Getting rid of Qualified Mortgage Insurance

Using a conventional loan, the buyer may cancel the PMI after paying 20 percent of the loan's value or 11 years, whichever comes first. Nevertheless, the FHA may prohibit you from taking this reduction and it depends on the origination date of the loan.

• For loans originated between December 31, 2000 and July 3, 2013, if you have paid off at least 78 percent of the loan-to-value (LTV) amount, you may request cancellation of the MIP from the lender.

• For loans originated after July 3, 2013, unless you made a down payment of less than 10% of the home's value at closing, you must pay the MIP for the life of the loan till your down payment was less than 10%. Refinancing an FHA loan into a non-FHA product is the only way to remove the qualified mortgage insurance premium (MIP).

Borrowers who are eligible for a conventional loan, even if they will be required to pay private mortgage insurance, should also investigate FHA loans to determine which is the better deal. Those with lower credit scores may fare better with an FHA mortgage, especially if they are able to put down 10% of the purchase price. Additionally, some lenders may offer a separate loan to cover the amount of the down payment. Consult your tax accountant, financial advisor, and bank to determine which loan makes the most sense given your circumstances.

Tax Implications of Qualified MIP (Mortgage Insurance Premiums)

Each year, your lender must send you and the Internal Revenue Service a Form 1098 Mortgage Interest Statement (IRS). This form details your mortgage payments for the previous year and can impact your income tax liability. In box 5 of the form, the total amount of MIP or PMI premiums will be listed. To deduct either type of mortgage insurance, you must itemize your deductions on Schedule A under the section for interest paid.

Due to the passage of the Tax Cuts and Jobs Act of 2017, the deduction for these premiums expired on December 31, 2017. However, with the Further Consolidated Appropriations Act of 2020, The Congress extended the deduction until December 31, 2020. This indicates that the deduction was available for the 2019 and 2020 tax years, as well as for the 2018 tax year.

Special Considerations

Not everyone is eligible to deduct for qualified mortgage insurance premiums  (MIP). eligibility is dependent upon filing status and adjusted gross income (AGI). The deduction is reduced by 10% for each dollar in excess of the borrower's maximum AGI. It is completely eliminated for those with incomes above $54,500, or $109,000 for joint filers.