Mortgage Insurance Premium vs. Private Mortgage Insurance: What’s the difference?

Mortgage Insurance Premium vs. Private Mortgage Insurance: What’s the difference?

Down payments serve two purposes: one is to lower the amount of principal and interest the borrower pays each month. The other is to lower potential risk for the lender—whether that’s a bank or another type of lending institution. For many buyers, however, having the option to put less money down makes it possible to afford a home more quickly, or ever.

Fortunately, today’s market offers several types of loans that, when combined with either Mortgage Insurance Premium (MIP) or Private Mortgage Insurance (PMI), enable a borrower to put less than 20%. This is because the two distinct types of insurance protect the lender should the borrower default on the loan.

While MIP and PMI are designed to do the same thing there are a few key differences.

What is Mortgage Insurance Premium? (MIP)

Mortgage Insurance Premium (MIP) is insurance a borrower secures when taking out a Federal Housing Administration (FHA) loan and could allow buyers to fund as little as 3.5% of the purchase price through their down payment. All borrowers are required to pay MIP through the duration of their mortgage term or 11 years, at a minimum, depending on the initial down payment amount.

In short, LTV calculates the ratio between what you finance through your lender and the value of the property.

If you’re taking out an FHA loan, it’s important to understand MIP, because you will be required to pay monthly premiums. You may also be assessed an upfront cost at closing. Homebuyers who can’t afford the up-front fee can roll the expense into their mortgage, but it’s important to know that this will increase how much you borrow as well as your monthly mortgage payment.

What is Private Mortgage Insurance? (PMI)

Borrowers who put less than 20% down on a conventional loan are also required to take out coverage in the form of Private Mortgage Insurance (PMI) which could lower your down payment requirement to as little as 3%. In this case, your lender will arrange for insurance through a private carrier.

Private Mortgage Insurance vs. Mortgage Insurance Premium: Which one is better?

Private Mortgage Insurance monthly payments are determined by how much you put down and your credit score. Borrowers with better credit will pay less than borrowers with lower credit scores, but in general,  PMI coverage costs less than MIP. PMI is also paid monthly with little to no money owed at closing.

Another of the advantages over the life of the loan is that PMI can most often be eliminated once you have built 20% equity in your home. Simply write your lender and request that the coverage be dropped. You will need to pay for an appraisal to confirm the property’s value, but if you’re willing to wait a bit, your bank will automatically drop the coverage once you’ve built a 22% equity stake in your home.

Can I Take Out Private Mortgage Insurance Instead of Mortgage Premium Insurance?

When purchasing a home, you’ll be shopping around for private homeowners’ insurance, looking for the best price for your coverage, so it’s logical to wonder if you can also find and secure your own private mortgage insurance. Unfortunately, the answer is, “No.”

Whether you’ll be required to pay for PMI or MIP is dictated by the type of loan you secure.

Buyers with an FHA loan are required to pay MIP and cannot take out their own mortgage insurance through a private agent.

Likewise, buyers who secure financing with a conventional loan will be assigned PMI by their lender. The good news is that premiums for both types of insurance are based on factors related to your home value or credit score, so shopping around for better pricing isn’t necessary. Your premiums will be the same for any mortgage insurance provider your lender chooses.

The Upside to Mortgage Insurance

Loans that require mortgage insurance offer a silver lining for homebuyers, thanks to the lower down payment requirement. Despite the cost of insurance, this down payment flexibility enables many would be homeowners to enter the real estate market, and possibly sooner!