Mortgage insurance premiums and private mortgage insurance allow more borrowers to qualify for loans who may not otherwise. Mortgage insurance acts as an additional risk protection to the lender who is extending credit to the borrower by covering the lender in the event that the borrower defaults. It is a similar to a credit default swap made famous in the The Big Short.
Mortgage insurance premiums (MI or MIP) apply to FHA loans, which are guaranteed by the federal government regardless of how little or much down payment you make. Private mortgage insurance (PMI) applies to conventional loans when you make a down payment of less than 20%. Conventional (also called conforming) loans are mortgages offered by private lenders without a government guarantee but may end being picked up by Fannie Mae or Freddie Mac. Mortgage insurance may be required on either the initial purchase or a refinance.
FHA MI, Conventional PMI, Oh My!
FHA loans have upfront premiums in addition to monthly amounts. Every person who buys a house with an FHA loan has to pay an upfront premium which is currently 1.75% of the purchase price of the house whereas conventional loans do not have this requirement.
Generally, both MIP and PMI require monthly payments but are quoted on an annual basis. For FHA loans, The cost of MIP depends on the term (lower term, lower MI) of your mortgage, the amount of your base loan amount, and your loan-to-value ratio (LTV). While the premium cost can vary from borrower to borrower, the annual cost of MIP generally runs between 0.45% and 1.05% of the loan amount. This MI payment will not slide down as you pay the loan down. FHA MI is less sensitive to lower credit score borrowers – this is one of the few time Mortgage-Analyzer would recommend pursuing this type of loan.
As opposed to FHA loans, if you make a down payment of greater than 20%, the lender will not require you to pay PMI. If you are putting down less than 20% on conventional, you likely will have to pay PMI (Note: exceptions such as piggy-back loans exist but come with higher interest rate to compensate the lender for additional risk). The cost of PMI is affected by factors like your credit score and the amount of your down payment. The general range is 0.5% and 2% annually of the mortgage.
The length of time that you have to carry the mortgage insurance varies between MI and PMI. If you buy a house today with an FHA loan, you will be required to pay MIP for the lesser of 11 years or when you reach 78% LTV. If you make a down payment of less than 10%, the MIP will stay for the entire term of the loan (Yikes!).
Current legislation allows for conventional PMI to be removed once a property reaches 80% LTV which can happen much sooner than expected, especially in high growth areas. Like the >10% down payment FHA loans, the PMI will burn off automatically at 78%. Speeding up principal payments monthly or with a lump sum may make sense but the opportunity cost of your money needs to be weighed.
Should I get a loan/refinance with MIP or PMI?
There are several factors to consider such as how much down payment you can afford, credit score, and current LTV (if refinancing). If you can come up with 5% down and have decent credit, Mortgage Analyzer would highly recommend getting a conventional loan as the PMI will not stay on the loan the whole term and it winds down as you pay the loan principal down. If you can only make the 3.5% down payment and/or have lower credit, then the FHA is going to be your choice and you will want to keep an eye on refinancing soon. Getting good answers to these questions can be tough and that is why we have vetted top lenders to help get you the best loan to match your needs.
How to reduce or eliminate your mortgage insurance
FHA Loans: For loans made after June 3, 2013 with a down payment of at least 10%, you may be able to cancel the MIP payments after 11 years or if you have reached 78% LTV (usually sooner depending on loan term). If you made a down payment of less than 10%, you will need to pay MIP for the full term of the mortgage – a mortgage refinance will be your only way out. Before pursuing a refinance and potentially losing hundreds on an appraisal that isn’t high enough, understanding how much home equity you have is the most important factor. For older FHA loans, please refer to HUD for details.
Conventional Loans: Under current law, the mortgage lender or servicer is required to drop your PMI when one of two things happens:
First, the provider must automatically terminate PMI when your mortgage balance reaches 78 percent of the original purchase price, provided you are in good standing and haven’t missed any scheduled mortgage payments.
Or, second, the lender or servicer is also required to stop the PMI at on the midway point of the term (so after 15 years of a 30 year loan). Even if your mortgage balance hasn’t yet reached 78 percent of the home value, the PMI must be cancelled.
Current law affords you the right to ask for PMI cancellation once your loan balance reaches 80% of the home’s value. If you’re making payments as scheduled, you can find the date that you’ll get to 80% on your PMI disclosure form or request it from your loan servicer.
You may also be able to hack this if your property value has increased while you have been paying down your loan – the risk is that you could lose the $300-800 on the appraisal coming back too low
Refinancing a conventional loan comes with the same risks as an FHA in that the borrower could go through the entire process, pay for an appraisal, and then not have enough equity to remove the mortgage insurance.
At Mortgage Analyzer, we believe in being more informed than your lender. Know your rights and exercise them. You can seek out mortgage insurance reductions or elimination. Home values fluctuate constantly and there has been a tremendous surge in all asset prices over the last decade. It is highly likely you can take advantage of these strategies and save real money that you can put to work.