MIP vs PMI: Breaking Down Different Types of Mortgage Insurance

If there’s one thing you’ll learn while preparing for a home purchase, it’s that real estate can be expensive – especially when you add up all of the affiliated costs, from monthly mortgage payments to property taxes and even insurance. Many homeowners will be thrilled to find any way they can reduce those costs.

One portion of the monthly mortgage payment that can, in some situations, be avoided entirely is the private mortgage insurance for conventional loans or mortgage insurance premium for FHA loans. It’s important to note that this is not the same as homeowner’s insurance and is a different type of expense.

By making a larger down payment upfront, building equity, or refinancing, a borrower may be able to reduce or remove this type of insurance obligation.

What is Private Mortgage Insurance?

Private mortgage insurance – or PMI – is a policy designed to protect a lender if a borrower defaults on their home loan.

This is an important concept to understand, so read it again if necessary. Unlike homeowners insurance or car insurance, the primary purpose of mortgage insurance is to protect the mortgage lender from major losses if the borrower doesn’t make their monthly payments.

Lenders offering conventional mortgages will require the borrower to pay for insurance if they determine the financial situation justifies it.

Specifically, if the borrower makes a down payment that is equal to less than 20% of the total mortgage loan amount, then they generally will be required to pay mortgage insurance premiums – essentially, an additional fee – until they have paid off enough of their loan principal to achieve at least 20% equity in the home.

These payments are usually rolled into the monthly mortgage payments.

How is a Borrower’s PMI Determined?

The premiums for PMI are calculated as a percentage of the total loan cost and the size of the initial down payment. Your credit score, debt-to-income ratio in addition to the type of property can also impact your PMI.

FreddieMac offers a calculator you can use to receive an estimate of your potential mortgage insurance premiums.

What is Mortgage Insurance Premium?

A Mortgage Insurance Premium, or MIP, is a type of mortgage insurance payment required for Federal Housing Administration loan borrowers.

FHA loans are often used by first-time homebuyers. Because they’re backed by the FHA, they typically have looser requirements to allow borrowers with lower credit scores and higher DTIs to obtain loans. In exchange for easier requirements and preferable rates, the borrower must make MIP payments to pay for FHA mortgage insurance.

In most cases, FHA borrowers must continue paying their mortgage insurance premium across the entire life of the loan. Depending on when you took out your loan and how much of a down payment you put forward, you may be able to eventually get rid of the MIP.

You can finance the insurance costs as part of the loan, but this will lead to a higher loan balance, which can also translate into higher monthly payments and overall lifetime costs.

How is a Borrower’s MIP Determined?

An FHA borrower’s insurance premium amount is calculated using an MIP rate that varies depending on loan amount and loan-to-value ratio, or LTV. The LTV, as the name suggests, is the ratio of the cost of the loan compared to the home’s value (which is determined by an appraisal).

The MIP rate is then multiplied by the annual cost of the loan to calculate the annual premium. The annual MIP can be divided by 12 to determine how much it will cost the borrower each month.

The Department of Housing and Urban Development has a guide to help calculate FHA MIP costs.

Key Differences Between PMI and MIP

The main difference between PMI and MIP is the type of loan they accompany. PMI may be required for conventional mortgages while MIP is always required for FHA loans.

Another significant difference between PMI and MIP lies in the nature of the requirements. According to Fannie Mae, PMI will usually fall off when your loan balance reaches 78% of its original value, as long as you are current on your mortgage payments. However, you can request that your lender remove the PMI once you’ve achieved 20% home equity (meaning, the remaining loan amount is for 80% or less of the home’s purchase price).

Depending on your down payment amount and interest rate, refinancing to another loan type may be the best way to get rid of MIP. However, if your down payment is large enough, you may be able to drop the MIP after a certain number of years.

How to Avoid or Minimize Mortgage Insurance with a Conventional Loan

The simplest way to avoid private mortgage insurance on a conventional loan is by making a 20% down payment upfront. While this may be “simple,” it is not always easy.

Depending on the cost of the home you are trying to buy and individual financial circumstances, a 20% down payment can be a challenging upfront cost. If you know you’re going to be looking into homeownership in the next few years, you should try to increase your savings so that you can make a larger down payment.

Even if you can’t reach the full 20% lump sum, a larger down payment will offer better loan terms and get you closer to the equity requirement for dropping the mortgage insurance.

Some lenders may also offer a “piggyback mortgage” that allows a borrower to take out two mortgages at once. The goal is typically to help cover the difference for the down payment in order to avoid PMI.

According to the Consumer Financial Protection Bureau, this type of piggyback structure is rare now, but was more common during the housing boom before the 2008 financial crash. Even if you find a lender offering this type of mortgage, you should be very careful to do the math, as it could be more expensive to pay off a second loan than paying the insurance requirements until you reach 20% equity.

You may also be able to consider Lender Paid Mortgage Insurance, or LPMI. This is when the cost of mortgage insurance is financed by the lender as part of the loan. While this may be worth it if the home is an investment property that you’re planning to flip in a couple years, make sure to do the math to be certain your quest to avoid PMI isn’t costing you more in the long run.

How to Avoid or Minimize Mortgage Insurance with an FHA Loan

If you took out an FHA loan, then you

may have to refinance with a conventional loan to get rid of your MIP requirement. Whether or not this is a good idea comes down to each individual situation. Just remember when running your calculations: You can expect to pay another round of closing costs when you refinance. You will also want to pay attention to the new loan terms.

Finally, if you are a veteran or current armed services member, you can access VA loans. VA loans do not have a down payment or insurance requirement, so they can be the best and most affordable option for qualifying borrowers with veteran or military status.

The Bottom Line

Odds are you won’t really be choosing between PMI or MIP. It’s more likely that you’ll be choosing between a conventional loan and an FHA loan, and then will need to manage the insurance requirements accordingly.

It’s still important to understand the differences between PMI or MIP, however, as it can be a factor in determining whether you’d like to consider an FHA loan. For example, even if you’re eligible for an FHA loan, you should be aware that preferable rates can be counterbalanced by the requirement for Mortgage Insurance Premium payments.

Understanding the ins and outs of mortgage insurance requirements will help you understand what type of mortgage makes the most sense for you.