Whether you’ve bought a house in the past or are looking to buy one in the near future, one of the most common questions people ask is “what is mortgage insurance?” Most people have negative connotations with the terms “mortgage insurance,” “PMI” (which stands for private mortgage insurance), or “MIP” (which stands for mortgage insurance premium), but for many Americans, it is an important component of their path to homeownership. So, what is it, exactly?
Put simply, when a home buyer puts a down payment on a home that totals less than 20% of the home’s sale price, they are going to have to pay into an insurance fund every month when they make their mortgage payments. This amount, which lowers the financial risk a lender takes when they lend to a borrower, is added to the amount that is paid on each monthly mortgage payment.
The portion of the payment that is designated as the mortgage insurance payment then goes into a universal fund that is used to insure the lender against the default of all of its borrowers.
In laymen’s terms, mortgage insurance premiums protect the lender against borrowers who might default on their loans–or not pay them as agreed. It is important to note that mortgage insurance protects the lender–not the borrower–against default on the loan. If a borrower stops making payments on their mortgage, the mortgage insurance premium fund can be used to protect the interest and owned property of the lender.
The Difference Between MIP & PMI
The primary difference between MIP (mortgage insurance premium) and PMI (private mortgage insurance) is the type of loan a borrower has. MIPs apply to Federal Housing Administration, or FHA loans, while PMI premiums apply to conventional loans.
If you get a conventional home loan, your lender will arrange for a PMI policy with a private insurance company. The rate used to calculate PMI varies based on the amount of down payment received on the loan and the borrower’s credit score. The borrower can choose to pay the PMI premium monthly alongside a one-time PMI fee that is charged as a lump sum, or they can have the PMI fee rolled into their total loan amount.
For government FHA borrowers, MIPs are charged by a flat rate regardless of down payment size or credit score (unless, of course, the borrower puts 20% or more down on the loan, in which case there would be no mortgage insurance). These premiums are paid directly to the Federal Housing Administration. There is usually an initial fee for the insurance policy as well as monthly premium amounts, but the initial fee can be rolled into the cost of the loan if the borrower chooses (although this would increase the costs associated with the loan).
The VA Loan Guaranty Program
VA loans do not have mortgage insurance associated with them. However, they do have a loan funding fee that is exclusive to the VA loan program. This fee is paid to the Veterans Administration and funds the VA loan program so that veterans can continue to take advantage of it in the future. Like mortgage insurance, the VA loan guaranty fee can be rolled into the cost of the loan.
Government-backed USDA loans also require mortgage insurance. Because USDA loans have no down payment requirement, they require mortgage insurance. Mortgage insurance on a USDA loan consists of an up front guarantee fee as well as monthly mortgage insurance payments that are part of the mortgage payment. In general, USDA loan mortgage insurance fees are lower than those charged for FHA loans. However, USDA loan mortgage insurance premiums are charged for the life of the loan, regardless of loan-to-value ratio.
Removing or Reducing Your MIP or PMI
Remember, MIP and PMI only apply to loans where a borrower pays less than 20% down on the loan. If you are able to make a 20% down payment, you will not have to pay mortgage insurance on FHA or conventional loans.
For FHA loans, MIP rates fluctuate based on what the federal government designates them to be. MIP rates fell drastically in 2015. When MIP rates fall, this does not mean the fee homeowners with FHA loans are paying automatically falls as well. In order to take advantage of lower mortgage insurance rates, a homeowner must refinance their loan.
FHA loan mortgage insurance premiums can be removed under specific circumstances, but it isn’t as simple as having them removed once your loan-to-value ratio reaches 80%. Your lender can provide you with more detailed information regarding mortgage insurance on your specific FHA loan. In some cases, refinancing might be necessary to completely eliminate FHA MIPs.
For conventional loans, a borrower may request the PMI be removed once their loan-to-value ratio goes above 80% so long as they have a good payment history on the mortgage loan. In order to request PMI cancellation, the borrower must notify the lender in writing.
The lender is required to eliminate the PMI payment on conventional loans without borrower request once the loan-to-value ratio dips below 78%.
For More Information
If you are considering purchasing or refinancing a home and have questions about MIP or PMI, contact one of NLC Loans’ Personal Mortgage Advisors toll-free at 877-480-8050. Our friendly, knowledgeable staff will listen to your concerns, answer your questions, and get to know you and your personal situation so that you can make the best financial choices for your unique desires and goals.