The real estate industry has a trade-off between consumers and lenders. Consumers can get a mortgage with a small down payment, but lenders are then protected with buyer-paid mortgage insurance that repays the lender should the borrower default on the mortgage.
One type of insurance is called Mortgage Insurance Premium (MIP) and the other is Private Mortgage Insurance (PMI). This article will answer questions such as what is PMI, what is MIP, what is the difference between MIP and PMI, how much does mortgage insurance cost and whether buyers must always pay for this insurance. Let’s start with the basics:
What Is Mortgage Insurance Premium (MIP)?
The Federal Housing Administration (FHA) requires that all its loans be insured. The mortgage insurance for FHA loans is called the Mortgage Insurance Premium (MIP). The annual MIP is paid upfront at closing and also monthly once the mortgage begins. The monthly premium is based on a percentage of the loan amount at closing. The Department of Housing and Urban Development (HUD) holds the monthly fee in an escrow account.
The Mortgage Insurance Premium (MIP) protects the lender from loss if the borrower defaults. If this occurs, the lender is reimbursed by the FHA for the remainder of the mortgage. MIP is required on all FHA loans, regardless of the amount of the down payment.
Although it’s a fee that isn’t designed to protect the borrower directly, MIP benefits homebuyers. It allows them to put down only 3.5% on an FHA loan. Without MIP to protect the lender, the down payment requirement would be much larger.
What Is Private Mortgage Insurance (PMI)?
Private Mortgage Insurance (PMI) is required for all conventional loans if the borrower has less than a 20% down payment. Like MIP, PMI protects the lender if the borrower defaults on the mortgage. A PMI mortgage is also required on a refinance if there’s less than 20% equity in the home.
PMI can be paid at closing or in monthly premiums added to the mortgage payment. Lenders can choose how they want the PMI to be paid.
Some lenders can also provide a loan with less than 20% down and no PMI if the borrower will accept a higher interest rate. If 20% or more is put down, PMI is not required.
VA and USDA loans do not require PMI, even though they are zero-down loans. However, each has funding fees, usually between 2% t 2.25%.
Since it eliminates PMI if at all possible, putting down 20% on a conventional loan helps to lower your mortgage payment.
What Are The Differences Between PMI and MIP?
The biggest difference between PMI and MIP is the type of mortgage each covers. PMI covers conventional loans, while MIP is generally for FHA loans. Other differences are that credit scores and loan-to-value ratios influence the cost of PMI, while MIP is based on the loan amount and loan term. PMI can be removed once a home with a conventional loan accrues 20% equity or the loan balance drops below 80% of the purchase price and MIP can be removed with a 10% down payment after 11 years of on-time payments or if one refinances into a conventional loan.
Is PMI or MIP More Expensive?
Upfront MIP requires a payment of 1.75% of the loan amount. On a $300,000 mortgage, the borrower would pay $5,250 at closing. Annual MIP varies between 0.15% and 0.75% of the loan amount. On a $300,000 FHA loan with less than 5% down, the annual MIP rate would be 0.55% or $1,650.
PMI rates vary between 0.22% and 2.25% of the mortgage. On a $300,000 mortgage, the PMI would be somewhere between $660 and $6,750.
Therefore, while PMI is more expensive upfront, it’s either paid at closing or monthly, but not both. Over time, MIP becomes more expensive. However, PMI could be more expensive on a conventional loan if the borrower’s credit score is low or if the down payment is small.
How Long Do You Have to Buy PMI
Fortunately, PMI does not have to be paid forever. There are two ways to remove it from your monthly payments. The first is if the loan balance drops below 80% of the purchase price. the second is once you have at least 20% equity built up. On a $300,000 mortgage, that would mean paying off $60,000 of principal.
How Is Your MIP Determined?
The MIP depends upon four factors:
- The total amount of the loan
- The loan term
- The amount of down payment
- The loan-to-value (LTV) ratio, i.e., the ratio of the loan amount to the home value.
The monthly MIP amount can be calculated by dividing the annual amount by 12. Since both FHA and Conventional mortgages are considered qualified, the lender must calculate your ability to repay the loan principal and interest, as well as all taxes, insurance and fees including MIP or PMI.
Can You Remove Mortgage Insurance Premiums From an FHA Loan?
The good news is that you can remove Mortgage Insurance Premiums from an FHA loan. With a down payment of at least 10%, the MIP expires after 11 years of payments, but only if you have made on-time payments every month.
Another option is to refinance an FHA loan into a conventional loan to remove MIP. However, you will need 20% equity in the home and a minimum credit score of 620. In addition, there will be closing costs on the refinance, so you would have to see if the closing costs will be more or less than the savings from removing MIP. If not, it may pay to wait until the 11 years are completed.
What Type of Mortgage Insurance is Best for Me?
The type of mortgage insurance you receive will be based on the type of mortgage you choose or for which you are qualified. If you have 20% down and a high credit score, you can take a conventional loan and not be required to have private mortgage insurance. You must have a PMI mortgage if you have a high credit score but lack the 20% down payment. However, if you make all of your payments on time, once you build up 20% equity in the home you can have the PMI removed. Ask your lender how to remove mortgage insurance.
On the other hand, if your credit score is only fair or good, you may only qualify for an FHA loan. If that’s the case, you will be required to have MIP. PMI is not meant for FHA loans.
Conclusion
There are two types of mortgage insurance: PMI and MIP. PMI is required for conventional loans with a down payment of less than 20% and MIP is required on FHA loans. Mortgage insurance protects the lender in case the borrower defaults on the mortgage. Although it’s a fee, the insurance benefits the buyer because it eliminates the 20% down payment requirement.
Your lender can help you determine which type of mortgage is best for you, how much money to put down and how much MIP or PMI you will be required to pay.