Did you know 56% of home buyers put less than 20% down on their mortgage in 2019?
It’s a common practice and helps home buyers build home equity instead of waiting to save for a 20% down payment. If you’re planning to buy a home with less than 20% down, you’ll need to understand the differences between the two types of mortgage insurance.
There are private mortgage insurance (PMI) and mortgage insurance premiums (MIP). PMIs often accompany conventional loans, and MIPs are often required for Federal Housing Administration (FHA) loans.
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When comparing PMI vs MIP, there are differences in how long you’ll have to pay each loan, and how much you’ll have to pay. Read on to learn more about these two forms of mortgage insurances.
What is PMI?
There are two instances in which you may need to buy private mortgage insurance; when you’re taking out a home loan or refinancing your home. If your lender is requiring you to buy PMI, you have a high loan-to-value (LTV) ratio.
Homeowners with high LTV ratios are required to get PMI because it protects the lender if the homeowner defaults on their mortgage. Lenders generally require a PMI if the LTV meets one of two qualifications:
- The downpayment on the mortgage is less than 20%
- The loan-to-value ratio is over 80% (this only applies to refinancing)
To calculate your LTV, simply divide your refinanced mortgage by the home’s value.
The nice thing about PMI is that lenders typically find an insurance provider for you. The homeowner is responsible for paying the PMI, which usually costs $30-$70 each month.
The good news is you don’t have to pay the PMI for the entire length of your mortgage. PMIs can be canceled once you build 20% home equity. The same is not true of mortgage insurance premiums, as explained below.
What is a MIP?
You’ll have to pay mortgage insurance premiums if you can’t put down 20% on an FHA-backed loan. FHA-backed loans are designed for people who don’t qualify for conventional loans because of low credit scores, low to moderate income, or low down payment.
The catch is that since FHA loans only require a minimum of 3.5% down, the loan requires additional payment to offset the risk to the lender. The FHA has two different rules for how long you’ll have to pay mortgage insurance premiums.
- If your LTV is over 90%, you’ll have to pay MIP annually for 30 years or until you pay off the loan.
- If your LTV is less than 90%, you’ll have to pay MIP annually for 11 years, or until you pay off the loan.
Both PMI and MIPs balance the risk to the lender by requiring additional payments from the home buyer. Compared to PMI, however, some MIPs require you to make insurance payments for much longer and sometimes for the entire life of the loan.
How Should You Decide Between PMI vs MIP?
The best way to keep your overall mortgage payments low is by putting 20% down on your home. Since this isn’t always possible, the next best option is to compare your options with regards to PMI vs MIP. You should first see if you can get a conventional loan with PMI and begin to build towards that 20% equity threshold.
If you’re unable to get a conventional loan, your next best option is the FHA-backed loan and accompanying MIP. If you have more questions about buying a home, stay up to date with our blog to learn everything there is about the home buying process.