A mortgage is a big commitment. When you’re buying a home, your lender wants to know you’re in it for the long haul, and capable of paying for it. For the mortgage lender, a client can show that by making a 20% down payment on the home.
Even when 20% down isn’t possible, lenders are still willing to give you a chance. The catch? They may require you to get mortgage insurance. Mortgage insurance is a monthly fee paid to a third-party insurer. It’s designed to protect the lender if you can’t make your mortgage payments.
The benefit of mortgage insurance? You can make a smaller down payment on your home.
The drawback of mortgage insurance? It adds to your monthly mortgage payment.
Types of Mortgage Insurance
There are two key types of mortgage insurance:
- Mortgage Insurance Premium (MIP)
- Private Mortgage Insurance (PMI)
Because the terms sound the same and serve the same function – right down to the similar-looking acronyms – they are easy to mix up.
What Is A Mortgage Insurance Premium (MIP)?
MIP is the mortgage insurance associated with Federal Housing Administration (FHA) loans. It is designed to help first-time home buyers and low-credit and low-income borrowers become homeowners. MIP offers better interest rates and allows borrowers to make down payments as low as 3.5%.
While FHA loans are backed by the government, they still tend to be high-risk for the lender to take on, so MIP can cost more and have less flexibility when compared with PMI.
How much is MIP on an FHA loan?
Two premiums of MIP determine its cost:
- An upfront mortgage insurance premium (UFMIP) equal to 1.75% of the loan amount that is usually added to the closing costs. For example, if you’re taking out a $300,000 loan, you’d pay an additional $5,250 at closing.
- An annual premium that is divided by 12 and added to your monthly premiums. The annual premiums range from 0.45% to 1.05% of the loan amount. If your annual premium is on the higher end, say 1%, then on that same $300,000 loan you’d see an annual premium of $3,000 ($250 each month).
The premiums are based on:
- The loan-to-value (LTV) ratio: While FHA loans can have down payments as low as 3.5%, a 5% or 10% down payment can lower your monthly payments and shorten the length of time you’ll need to pay down the loan.
- Amount borrowed: Loans valued at more than $625,000 will require the borrower to pay more for MIP.
- Length of loan: 30-year loans will have a higher MIP than loans with shorter terms.
Can you get rid of MIP?
Well, it depends on the terms of the loan. You could be paying MIP for either 11 years or the life of the loan, depending on your down payment. Generally, the only way to remove MIP is by refinancing with a non-FHA loan once you have 20% equity in the home.
What Is Private Mortgage Insurance (PMI)?
Private mortgage insurance (PMI) is associated with conventional mortgages. Because conventional mortgage borrowers are considered lower risk, there’s greater flexibility in terms.
How much does PMI cost?
The cost of PMI can vary because it’s determined by the lender based on the loan amount and risk factors like your credit score.
PMI can range anywhere from 0.5% to 2% of the initial loan amount but usually hovers around 1%. On average, that can add between $30 to $160 a month for every $100,000 of home that you buy. PMI on a $300,000 home could add between $100 to $500 to your monthly mortgage payment.
Most borrowers opt for borrower-paid mortgage insurance, where you pay a monthly fee directly to the insurer. You can also choose single-premium mortgage insurance, where you pay a lump sum at closing. That lump sum is then treated like a closing cost that you finance through your monthly mortgage payments.
When can you stop paying PMI?
Your lender must stop charging you PMI once you’ve paid off 22% of your mortgage’s loan-to-value ratio. You can also ask your lender about stopping PMI once you’ve achieved 20% equity in your home. If you go this route, you might have to pay for a home appraisal to determine the current value of your house.
What Is the Difference Between MIP and PMI?
To help decide which option makes more sense for you, here’s a side-by-side comparison.
|Loan Type||FHA Mortgages||Conventional Mortgages|
|Upfront Cost||1.75% of loan value||None|
|Annual Cost||0.45% to 1.05% of loan value||0.5% to 2% of loan value|
|Years Required To Pay||11 years (with a down payment of 10% or more) or the life of the loan||Ends when you’ve paid off 22% of the value of the loan or when you have 20% equity and request it be removed|
What Type of Mortgage Insurance is Best for Me?
If you can afford a 20% down payment toward your home, you can avoid mortgage insurance altogether. If mortgage insurance is required by your lender, the type of mortgage insurance will depend on the type of loan you take out.
While FHA loans have benefits for some home buyers, as a rule, PMI is usually preferable to MIP because of its flexibility, lower rates and potential to be removed in less time.
If your best mortgage option is an FHA loan, look for ways to improve your credit score and income. You may be able to refinance your mortgage to a non-FHA loan and get rid of your mortgage insurance.