If you are planning to purchase a home, it is important that you know the difference between two mortgage insurance types i-e Private Mortgage Insure (PMI) and Mortgage Insurance Premium (MIP).
What is Mortgage Insurance?
Mortgage Insurance is required when the down payment you put on your new home is less than 20%. Mortgage lenders take your down payment as an assurance or guarantee that you are able to afford the mortgage loan and can pay your monthly mortgage payments on time. The more money you offer in your down payment, the easier it is for the mortgage lender to trust you with his money.
When you cannot afford to pay at least 20% of your home value upfront, you must pay mortgage insurance to protect the lender in order to offset the default risk to the lender.
There are two type of mortgage insurance, PMI (Private Mortgage Insurance) and MIP (Mortgage Insurance Premium). Let’s discuss them in detail here
Private Mortgage Insurance
Private Mortgage Insurance (PMI) is an insurance policy that is used in conventional loans with a down payment of less than 20%. PMI turns out to be more flexible in terms as the insurance can be paid either in lump sum at closing (single premium PMI) or it can be added to your mortgage amount and incorporated into your monthly mortgage payments.
The amount for PMI varies depending on your borrower, the amount of the loan and the size of your down payment. Typically, it runs about 0.5% to 1% of your loan value.
Mostly people roll their PMI into their monthly mortgage payments, which means it is a monthly expense for them. Homeowners, usually do not consider the cost of it but it can be in thousands of dollars over the life of the loan.
Fortunately, there are a few ways to get out of these monthly payments in case of
- Lenders are supposed to remove PMI when the loan balance reaches 78% of the original home value
- If you have 20% equity in your home, you can request the lender to remove your PMI. However, your lender will only allow this if you had a good payment history of past 12 months.
- You can request your lender to cancel the PMI, when you reach to the half of your amortization period. This means, for a 30-year mortgage, you will reach the half in 15 years.
If you are thinking of getting a mortgage with PMI, know that many lenders will lend you the money with a little to no mortgage insurance requirements.
Mortgage Insurance Premium
Mortgage Insurance Premium (MIP) is somewhat similar to PMI, but it only applies to FHA (Federal Housing Authority) backed loans when the down payment is less than 20%.
MIP is collected in two ways, either as an upfront payment (UFMIP) at the time of closing or incorporated into your monthly mortgage payments (currently set at the 1.75% of the base loan amount).
Although FHA loans in general require a very small down payment (typically 3.5%). But depending on how much less than 20% you put down, you could be locked into MPI for a very long time or even for the life of your loan. Apart from this, the amount you pay for MIP in your monthly mortgage payments depends on the Loan-to-value (LTV) ratio and the length of the loan.
For How Long You will have to pay MIP?
According to FHA, you will have to pay MIP till
- When LTV (Loan-to-value) ratio is greater than 90%
You will have to pay MIP until the end of the loan term or for 30 years, whichever occurs first
- When LTV (Loan-to-value) ratio is less than or equal to 90%
MIP will be collected until the end of the loan term, or for 11 years, whichever happens first.
MIP vs. PMI
An important difference between MIP and PMI are the monthly insurance premiums. For MIP, every buyer who buys a house with an FHA loan must pay 1.75% up front insurance premium in addition to the monthly insurance premiums. In contrast, the cost of the annual premium for PMI can vary from borrower to borrower, it generally runs from 0.45% to 1.05% of the loan amount.
Unlike FHA loans, not every person who buys a house with a conventional mortgage is required to buy PMI. If you make a down payment of 20%, you will not need to pay for PMI.
Another important difference is the length of the time you are required to pay the mortgage insurance. You are required to pay MIP for at least 11 years. And if you make a down payment of less than 10%, you will be required to pay the MIP for the life of the loan.
However, the conditions for PMI are different than MIP. You can request the lender to remove your insurance if you meet certain conditions (which are mentioned above).
It is difficult to say one mortgage insurance policy is better than the other because it depends on a lot of factors. To find out, which insurance policy will be most suitable for you, you should consult a Mortgage Expert.
Our experienced Loan Officer will help you figure out the right mortgage insurance policy according to your financial situation.
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