The Ultimate Guide to Mortgage Insurance
Mortgage Insurance is a kind of insurance policy. It compensates an investor or lender for losses in the event of borrower default on a mortgage loan. In other words, mortgage insurance protects the lender if you fall behind on your payments.
Both public and private insurers may offer mortgage insurance. Mortgage insurance lowers the risk to the lender of making a loan to you. This helps you qualify for a loan that you might not otherwise be able to get.
This article covers details on Private Mortgage Insurance (PMI) and Mortgage Insurance Premium (MIP).
What is Mortgage Insurance?
When you lend money to someone, you want to be sure you’ll get it back. Your mortgage lender is no different: they want to know they’ll get their money back when they lend it out. Since a conventional mortgage is usually a fairly hefty loan, the lender wants a guarantee. These policies may also be known as mortgage guarantee, mortgage indemnity guarantee, or home-loan insurance.
PMI is usually required on mortgage loans for those who aren’t able to produce at least a 20% down payment for a traditional loan. So, lenders impose mortgage insurance on the borrower in order to protect the lender in case of default. Lenders turn to private insurance providers for this, hence the name Private Mortgage Insurance (PMI).
Typically, borrowers pay PMI monthly; it’s lumped into their mortgage payments. These payments are only for the purpose of providing the lender with protection and don’t reduce the loan principal. PMI can also sometimes be paid when the loan closes as a one-time payment. Different lenders have different policies, so be sure to ask what options your lender provides.
Is Mortgage Insurance Required?
While there may be a special case here and there where a lender doesn’t require PMI, lenders will usually impose PMI on loans where the borrower can’t produce the down payment requirement. Government loans, such as FHA loans, have a kind of mortgage insurance pre-imposed on them called a Mortgage Insurance Premium (MIP, covered later in this article) regardless of the down payment amount or purchase price.
In some instances, the mortgage insurance required by lenders becomes obsolete and can be dropped. For example, the FHA loan allows for the MIP to be dropped if the Loan-to-Value ratio (LTV) is 80%.
How Much Is PMI Per Month?
How much you pay for your lender’s insurance will vary, but it’s usually somewhere around 1% of the total loan value. Your costs are determined by the amount of your down payment and the status of your credit. There are several ways a lender can require PMI payments to be made, the most common being a monthly premium. FHA lenders usually require a one-time payment for the total insurance cost when the loan is closed.
How Do You Avoid Paying PMI?
You have a few options if you want to avoid paying private mortgage insurance on your conventional loan. Private mortgage insurance is tacked on to a conventional loan when less than 20% down payment is paid.
When lenders decide to require PMI, they are doing it to protect themselves from borrower default. Borrowers with bad credit and borrowers who can’t make at least a 20% down payment are typically subjected to PMI. However, borrowers who pose little or no risk to the lender usually don’t need to pay PMI. So if you have good credit, and you can make a down payment of 20% or more, you can avoid having to pay PMI.
Be aware, though—FHA loans always have mortgage insurance imposed, no matter the amount of the down payment. Because FHA loans are sought by borrowers who are looking for looser restrictions, a lender with good credit and a large down payment would probably be better off seeking a traditional loan.
How Do You Get Rid of PMI?
Private Mortgage Insurance (PMI) can be dropped off a loan after specific criteria have been met. Although the decision is up to the lender, it is typical for lenders to require the loan-to-value ratio (LTV) to be 80% before the PMI can be dropped. Each lender has different criteria, so make sure you know what you’re getting yourself into before closing the deal.
How Can I Avoid Paying PMI Without 20% Equity?
The first and most obvious way to avoid paying PMI is to pay the full 20% down payment. But of course, the majority of us are not blissfully sitting on a pile of cash in search of a home.
Find a conventional loan with a low down payment requirement and no mortgage insurance. Yes, such programs exist! If you have a credit score of 620 or higher, talk to your lender as you’ll likely qualify for many of the programs.
Find a lender-paid MIP or lender-paid mortgage insurance (LPMI). While this option does not eliminate having to pay the insurance premium, it changes the structure for how you pay. This option allows the flexibility to either pay a lump sum which will be determined by the lender, or the lender can make an adjustment to the mortgage rate which will ultimately result in a larger mortgage payment every month. This will remove having to make a secondary or separate payment for the insurance premium.
Another way to avoid PMI is to choose a VA loan. If you are currently or have served previously in the military you can seek out a VA Loan. VA loans require no down payment, no mortgage insurance, low rates, and there are looser credit requirements than a conventional loan. A VA loan should be the first option for any military veteran.
How Much Is PMI Per Month?
How much you pay for your lender’s insurance will vary, but it’s usually somewhere around 1% of the total loan value. The cost to you is determined by the amount of your down payment, and the status of your credit. There are several ways a lender can require PMI payments to be made, the most common being a monthly premium. FHA lenders usually require a one-time payment for the total insurance cost when the loan is closed.
What’s the Difference Between PMI and MIP?
Whether or not you’re a first-time homebuyer, you might be aware of mortgage insurance. But, you might not know there are two different kinds. Mortgage Insurance Premiums (MIP) and Private Mortgage Insurance (PMI) both reduce the lender’s default risk when borrowers purchase homes with less than a 20% down payment.
Although both types pass insurance costs on to buyers, PMI and MIP are different. PMI applies to conventional loans with more traditional down payments. MIP applies only to government-backed FHA loans. In both cases, the insurance costs are passed on to buyers.
While private mortgage insurance (PMI) generally exists to protect lenders for all types of home loans, MIP specifically protects FHA government-backed loans.
A MIP (Mortgage Insurance Premium) protects the lender regardless of the amount of the down payment. If the borrower pays 10% or more for their down payment, MIP can be canceled after 11 years. MIP consists of an upfront premium with a rate of 1.75% of the loan and an annual premium with a rate of 0.85%. Annual premiums tend to be lower for loan terms of 15 years or less and lower loan-to-value ratios.
Private Mortgage Insurance provides protection for conventional loans and is a guideline set by Freddie Mac and Fannie Mae and the majority of investors where the down payment is less than 20%. PMI is automatically removed once the loan balance has fallen to 78%.
Private Mortgage Insurance offers plenty of flexibility as it can be paid upfront at closing or it can be financed on a monthly basis. The PMI rate is dependent on the size of the loan and the loan-to-value ratio; typically the rates are in the range of 0.5% to 2% of the loan.
What Is a Mortgage Insurance Premium (MIP)?
There are several types of mortgage insurance that can be imposed by lenders, and FHA loans require a specific insurance called a Mortgage Insurance Premium (MIP). The MIP is a payout directly to the Federal Housing Administration (FHA) rather than a private company as a Private Mortgage Insurance (PMI) is. The MIP is an insurance policy used with FHA loans if your down payment is less than 20%. It is this policy that provides the security that makes FHA loans possible and affordable. The calculations for the MIP will vary depending on the loan-to-value ratio and the length of your loan with the bank.
The FHA assesses either an upfront MIP (UFMIP) at the time of closing or an annual MIP (AMIP) that is calculated every year and paid in 12 installments. The MIP is typically required to be paid in a partial lump sum when the loan is closed, and as additional monthly premiums that can extend the lifetime of the loan.
In some cases where the borrower doesn’t have the funds to pay the initial premium, the cost can be spread across the loan payments. This increases the loan payment costs but spares the borrower from the initial payment. The rate you pay for annual MIP depends on the length of the loan and the loan-to-value ratio (LTV ratio). If the loan balance exceeds $625,500, you’ll owe a higher percentage.
How Can You Get Rid of MIP?
MIP has two components:
upfront premium (UFMIP)
The upfront premium is often financed; those payments are added to the monthly payments for the mortgage loan. The UFMIP doesn’t count against the LTV value that is used to determine other thresholds.
Generally, the only way to get rid of MIP is to refinance the loan. There are never any prepayment penalties on FHA loans, so you can refinance any time you want.
However, if you received your FHA loan before June 2013, you are eligible for MIP cancelation after five years. There are some additional requirements: You must have 22% equity in the property, and you must have made all payments on time. For homeowners with FHA loans issued after June 2013, you must refinance into a conventional loan and have a current loan-to-value of at 80% or more.
When Can You Drop MIP on an FHA Loan?
In January 2017, the Housing and Urban Development Department (HUD) changed Mortgage Insurance Premiums (MIP) rates for FHA loans. Whether or not you can ever drop the MIP from your FHA loan depends on the total amount of the loan, the duration of the loan, and the Loan-to-Value (LTV) ratio.
On loans with terms of less than fifteen years, an LTV of less than 90% will mean that the running time of the MIP is only 11 years. In any other case where the loan term is less than fifteen years, the MIP runs for the entire duration of the loan.
Loans with a term of more than fifteen years have a little more leeway. On loans less than $625,500, the MIP duration can be reduced to 11 years if the LTV is less than 90%. Loans over $625,500 can have an MIP duration of 11 years when the LTV is less than 90%, but the amount you pay is variable based on the LTV.