What is Mortgage Insurance?

Mortgage insurance is one of the costs associated with purchasing a home that buyers often do not think about.

Mortgage insurance can help make homeownership more accessible to those who aren’t able to save for a large down payment.

By paying a mortgage insurance premium as part of your mortgage payment each month, borrowers can get into a home with less than 20% down – sometimes, they can get a loan with as little as 3% down.

Private mortgage insurance (PMI), and the FHA mortgage insurance premium (MIP) are two of the most common types of mortgage insurance. Which one you have will depend on the loan you get.

The basics…

Mortgage lenders want to minimize the risk they take when lending money to borrowers.

When you make a down payment, not only does it lower the amount of money you have to borrow – thus reducing the lender’s potential loss if you were to default on the loan – but it also gives you a financial stake in the home. When your own money is on the line, you’re less likely to default.

The lower your down payment, the higher the risk is for the lender. This is why, if you make a down payment below 20%, you’ll often need to pay for mortgage insurance.

The type of mortgage insurance you’ll pay for will depend on what type of loan you have. If you have a conventional loan, you’ll have PMI. If you have an FHA loan, you’ll have MIP.

It’s important to understand that mortgage insurance doesn’t insure you as the borrower. PMI and MIP both provide protection for your lender if you’re unable to make your monthly payments.

PMI vs. MIP?

PMI is for conventional loans, meaning your loan isn’t backed by a government program.

Conventional loans often fall into the category of “conforming” loans, meaning they meet the requirements to be sold to Fannie Mae or Freddie Mac.

PMI is typically required on conventional loans with a down payment below 20%. You’ll pay a portion of your annual premium each month as part of your monthly mortgage payment.

MIP is the mortgage insurance that is required on FHA loans, which are loans backed by the Federal Housing Administration.

MIP is required on all FHA loans, regardless of the size of your down payment. FHA loans require both an upfront mortgage insurance premium (UFMIP) as well as an annual premium payment, or annual MIP. UFMIP can be financed into your loan amount. Annual MIP is paid as part of your monthly mortgage payment

Differences…

Ability to cancel

Borrowers who put down less than 20% on a conventional loan are typically required to pay for mortgage insurance.

However, once you reach 20% equity in your home, you can request that your lender or servicer remove PMI from your mortgage. Otherwise, PMI will be cancelled automatically once you reach 22% equity.

Cancellation of mortgage insurance works differently for FHA MIP. In general, MIP can’t be cancelled unless you made a larger-than-average down payment.

If you made a down payment of 10% or more on your FHA loan, you’ll pay annual MIP for 11 years. If your down payment amount was less than this, you can’t cancel MIP and will pay for mortgage insurance throughout the life of the loan.

To cancel MIP with a low down payment, you’ll likely need to refinance into a conventional loan once you reach 20% equity.

Upfront cost

FHA loans come with both UFMIP and annual MIP.

UFMIP is equal to 1.75% of the loan amount and can either be paid in full at closing or financed into the loan amount.

By contrast, PMI is most often paid as an annual premium, with a portion of it included in each of your monthly mortgage payments. With this set up, you won’t have any upfront costs.

However, conventional loan borrowers may have the option to pay a single mortgage insurance premium in one lump sum at closing. In this case, you’d have an upfront mortgage insurance payment, and no annual costs.

Annual cost

In addition to the 1.75% UFMIP, FHA loan borrowers will also pay between 0.45% – 1.05% each year for their annual MIP.

The exact amount your annual MIP will cost depends on your loan amount, term and down payment.

For example, a borrower with a 30-year, $300,000 FHA loan on which they made a 3.5% down payment would have an annual MIP rate of 0.85%.

Your PMI rate will be determined by your down payment amount and your creditworthiness. Borrowers with good credit scores tend to get better rates.

PMI rates typically range between 0.58% – 1.86%, according to Urban Institute data.

Bottom line,

Ultimately, you aren’t going to decide which loan you should get based on its associated mortgage insurance premium alone. You need to take a look at the full picture, which includes your own financial and credit situation, to determine which loan type meets your needs and is the most affordable for you.