Comparing Private Mortgage Insurance vs. Mortgage Insurance Premium

Reviewed by Ebony HowardReviewed by Ebony Howard

Private Mortgage Insurance vs. Mortgage Insurance Premium: An Overview

If you plan to purchase a house and your down payment is less than 20% of the home’s price, you’ll need to know the differences between private mortgage insurance (PMI) and mortgage insurance premiums (MIPs).

Key Takeaways

• If you purchase a home with less than a 20% down payment, your mortgage lender will require you to buy some type of mortgage insurance to reduce the lender’s risk if you default.
• Private mortgage insurance (PMI) is required for conventional mortgage loans with a down payment of less than 20%.
• If you put less than 20% down on a Federal Housing Administration (FHA) loan, you’ll pay a mortgage insurance premium, which may last for 11 years or the life of the loan.
• FHA loans also require an upfront fee of 1.75% of the loan balance due at closing.

Private Mortgage Insurance

Private mortgage insurance (PMI) is an insurance policy used in conventional mortgage loans that protects mortgage lenders from the risk of the borrower defaulting on the loan. PMI helps buyers who cannot or choose not to make a 20% down payment to obtain mortgage financing at affordable rates.

Important

If you purchase a home and put down less than 20%, your lender will minimize its risk by requiring you to buy insurance from a PMI company prior to signing off on the loan.

The cost of PMI varies depending on your credit score, the type of loan, and the size of the down payment and loan. Typically, PMI costs 0.5% to 1% of the loan balance but can run as high as 6%.

The annual cost is divided into monthly payments, which you must make until your PMI is either:

• Canceled at your request because your home equity reaches 20% of the purchase price or appraised value. Your lender will approve a PMI cancelation only if you have adequate equity and a good payment history.
• Terminated when your loan balance is scheduled to reach 78% of the original value of your home.
• You reach the midpoint of the amortization period. I.e., 15 years on a 30-year loan.

Other types of PMI include single premium PMI, where you pay the mortgage insurance premium upfront in a single lump sum either in full at closing or financed into the mortgage, or lender-paid PMI (LPMI), where the cost of the PMI is included in the mortgage interest rate for the life of the loan.

Advisor Insight

Steve Kobrin, LUTCF
The firm of Steven H. Kobrin, LUTCF, Fair Lawn, NJ

Foreclosure and default are the two events against which the lender needs to be protected. I’ll add a third event for which they commonly want insurance: the death of the borrower.

Banks don’t want to chase grieving widows or widowers for money when their spouse dies. They often want you to take out life insurance so the surviving spouse can pay off the loan. It is not mandatory typically but is encouraged.

Many banks are in the life insurance business and hire people to sell this product. The policy is often term insurance that mirrors the performance of the loan. The face amount decreases as you make payments.

This seems like an excellent concept. However, in 25 years of selling life insurance, I have yet to see a decreasing term policy that is less expensive than a level term policy.

Mortgage Insurance Premium

Mortgage loans insured by the Federal Housing Administration (FHA) offer borrowers easier-to-qualify terms, including a down payment as low as 3.5% versus the traditional 20%. FHA-approved private lenders who issue FHA-backed loans are shielded from default risk by the FHA.

However, borrowers must pay a mortgage insurance premium (MIP) if they make a down payment of less than 20%. MIP is similar to PMI in that it’s an insurance policy that protects the lender, but the cost structure for the borrower differs from PMI. Also, you must pay an upfront fee at the loan’s closing.

Upfront Mortgage Insurance Premium (UFMIP)

The FHA also assesses an “upfront” mortgage insurance premium (UFMIP) of 1.75% of the loan balance paid at the closing. For example, a loan balance of $200,000 would cost $3,500 upfront at the closing ($200,000 * 0.0175).

Annual Mortgage Insurance Premium (MIP)

The annual MIP rate can depend on the size of the down payment, the loan balance, and the loan-to-value (LTV) ratio. MIP rates are higher for loans exceeding $726,200. The figures below are for loans that are equal to or less than $726,200.

• A 10% down payment: You would pay a MIP rate of 0.50% for 11 years.
• A down payment of 5% or less: You would pay 0.55% annually for the entire mortgage loan term.

For example, let’s say that after you make a 10% down payment, you take out a $200,000 loan. Your annual MIP would cost $1,000 ($200,000 * 0.005), or if paid monthly, $83.33 ($1,000 ÷ 12 months).

For loans with FHA case numbers assigned before June 3, 2013, FHA requires you to make monthly MIP payments for a full five years before MIP can be dropped for loan terms greater than 15 years. MIP can only be dropped if the loan balance reaches 78% of the home’s original price—the purchase price stated on your mortgage documents.

However, if your FHA loan originated after June 2013, new rules will apply. If your original LTV is 90% or less, you’ll pay MIP for 11 years. If your LTV is greater than 90%, you’ll pay MIP throughout the life of the loan.

What Are the Basic Differences between Private Mortgage Insurance and a Mortgage Insurance Premium?

Private mortgage insurance protects the lender if a borrower defaults and had made a down payment of less than 20% when buying a home. The monthly insurance premium is a percentage of the loan balance paid monthly by the borrower.

For loans backed by the Federal Housing Administration (FHA), the FHA requires borrowers to pay a mortgage insurance premium (MIP) annually based on a percentage of the loan balance. In addition, borrowers must pay 1.75% of the loan balance upfront at the closing.

How Do You Get Rid of Private Mortgage Insurance (PMI)?

Once you have 20% equity in your home, you can request your mortgage lender cancel PMI. However, your lender must automatically cancel PMI once your loan balance has been paid down by 22%.

How Can I Get Rid of the Mortgage Insurance Premium (MIP)?

If you made a down payment of less than 10%, you must pay the MIP for the life of the loan. If your down payment was 10% or greater, the MIP expires in 11 years. Otherwise, you can either pay off the loan or refinance the FHA loan into a conventional mortgage to eliminate the MIP before its expiry.

The Bottom Line

If you buy a home with a down payment of less than 20%, the mortgage lender requires insurance to protect them in case you default. Private mortgage insurance (PMI) protects the lender whereby the borrower must pay PMI monthly, which is calculated as a percentage of the loan balance. If you buy a home backed by the Federal Housing Administration (FHA), the FHA requires borrowers to pay a mortgage insurance premium (MIP) annually or in monthly installments and an upfront fee of 1.75% of the loan balance at the closing.

Read the original article on Investopedia.