PMI vs MIP: What You Need to Know, and How Homebuyers Can Save Thousands
There’s an epic battle raging in the mortgage world between two fierce and unyielding opponents: PMI and MIP. Both do essentially the same thing, but they aren’t the same. Let’s take a walk through both camps to get a better understanding of these much-maligned mortgage insurances.
What is Mortgage Insurance?
If you borrow using an FHA or conventional loan and have less than a 20% down payment, you’re going to have to pony up some extra cash for a mortgage insurance policy. “Mortgage insurance” is a general term that applies to any insurance policy that insures up to 20% of the value of your loan against loss -- to the bank.
If you were to default, you probably would escape debtor’s prison, at least in non-recourse states. The insurance policy would pay their part to the lender, and the lender would sell your house on the courthouse steps. It’s unfortunate, but that’s how mortgage insurance works. It can get you off the hook, were you to bite off more than you could chew mortgage-wise.
PMI and MIP: Twinsies, Almost.
If you borrow using an FHA loan, the mortgage insurance you’ll get is called “Mortgage Insurance Premium.” MIP applies to any FHA mortgage with a loan-to-value ratio of more than 78%. If you have less than 10% down, it’ll last for the term of the loan. If you have more, you’ll get off the hook when your loan-to-value reaches 78%.
Now, if you get a conventional loan, you’ll have “Private Mortgage Insurance.” With PMI, your rate is partially determined by your credit score, but tends to be much lower than that of MiP. It does the exact same thing, except that it will always be able to be terminated when you reach 78% loan-to-value ratio, or at the midpoint of the loan term, whichever happens first.
Obviously, this makes for some pretty big differences in cost over the long term. That’s why we made this neat chart.
MIP vs. PMI
Year 1 and Year 5 are pretty obvious, but just to be completely clear, “End of Term” is the point at which the loan is below the 78% loan-to-value ratio. This is where most mortgage insurances will either automatically drop off or allow you to request they be terminated (so kind of them).
As you can see, a buyer who could probably get either an FHA or a conventional loan for a home that’s priced at the national median is really not getting the better end of the deal with FHA’s MIP. In fact, they’re paying over $8,000 more just for the benefit of insurance that is basically to keep them from getting sued if they defaulted, maybe.
Keep in mind, however, that this is based on today’s rate and a matrix provided by MGIC, one of the largest PMI providers. The picture could be completely different tomorrow. If this borrower went to a lender who would write both loans, they’d be mistaken to take the FHA loan on under these specific circumstances. But sometimes it’s a different story, that’s why it’s good to get several loan estimates before choosing the mortgage that’s best for your situation.
Avoiding Mortgage Insurance Completely
Some people will do anything they can to avoid paying for mortgage insurance. There have been some pretty inventive combinations over the years, but the most common is what is known as “a piggyback loan.” A piggyback loan works by combining two parts: an 80% loan-to-value ratio first mortgage and a 15% loan-to-value ratio second mortgage (the piggy on the first’s back). Together, they make a 95% mortgage, but because neither loan is more than 80% the loan-to-value ratio, there’s no mortgage insurance requirement.
Oh, but there is a serious catch.
Second mortgages rarely come with the same rates as the first mortgage, since they are exposed to more risk should you default. In a default situation, the first mortgage, the big guy, gets all the money from the sale of your home on those courthouse steps we talked about, and he gives the second mortgage whatever’s left after the mortgage and fees are paid. If that’s enough to cover the second, great, but if it’s not, well, that’s a big risk the lender is taking.
To compensate for the money that may or may not be lost by the second mortgage lender (it may be originated by the same lender as the first, but the seconds are very often packaged and sold immediately), the second note will not only have a higher interest rate, it’ll often have a shorter term. Instead of 4.76% for 30 years, your second may be at 6.75% for 10 years.
Doing these sort of mathematical gymnastics may be fun for some people, but often it just isn’t worth the hassle. Piggybacks create more paperwork, more headaches for you because you now have two different lenders to deal with, and, frankly, don’t always provide much savings. Certainly explore them if you think you can do better, just don’t be surprised if the second has quite restrictive terms.
Need Help Sorting Out Your Options?
We know that getting a mortgage can be confusing, especially when you’re juggling PMI, MIP, piggybacks, all while trying to save as much money as possible. We’re here to help, just contact us at Home.Loans and we’ll put pencil to paper to find the best combination for your budget.