PMI Versus MIP

Private mortgage insurance graphicIf you're considering purchasing a home, you've almost certainly heard the term "PMI" (private mortgage insurance). So, what is it exactly?
Private mortgage insurance (PMI) is a kind of insurance that mortgage lenders require of house buyers with a down payment of less than 20% on a "traditional" mortgage. Needless to say, many prospective homeowners are unwilling or unable to make a 20% down payment.
As a consequence, the lender will accept your down payment and seek the assistance of a private mortgage insurance company to "guarantee" the difference between your down payment and the required 20%.

If you make a 5% down payment, for example, the private mortgage insurance company will compensate the lender for the "missing" 15% down payment in the event of a mortgage failure. A "PMI" fee is paid to the private mortgage insurance company for the default guarantee. Private mortgage insurance companies provide a range of payment methods, including monthly payments, one-time upfront payments, and a combination of monthly and single premium payments. Another popular option is lender-paid private mortgage insurance.

Several mortgage lenders will pay the PMI charge on the borrower's behalf in exchange for a slightly higher interest rate.

How much is PMI insurance?

The down payment, the location of the property, the credit score, the term of the mortgage (15-year mortgages pay less) and a few other factors all have an effect on the cost of private insurance. In high-default states, private mortgage insurance is more costly.

Mortgage insurance premiums vary significantly across private mortgage insurers, and PMI rates change throughout the year. Private mortgage insurance is often paid in one of four ways.

The examples below illustrate the cost of PMI under different PMI schemes.

1. Monthly plan (also known as borrower paid MI)

The monthly PMI payment plan is the most common, most likely because it is the simplest computation for the loan officer. The following examples assume a 30-year loan with a "fixed" interest rate.

Here's an example of a monthly PMI premium.
Take note of how the monthly premium lowers as the down payment becomes larger.

Down Payment Percentage Loan Amount Credit Score Premium Factor MONTHLY COST
3% 194,000 700 0.99% 160.05
5% 190,000 700 0.78% 123.50
10% 180,000 700 0.55% 82.50
15% 170,000 700 0.25% 35.42
The mortgage insurance premium component rises as one's credit score falls and falls as one's credit score rises.

2. Borrower paid single premium

The one-time charge PMI is a one-time payment paid at the conclusion of the transaction (or financed with the loan). No extra payment is required to the mortgage company or a private mortgage insurance provider. Frequently, the single premium is coupled with seller-paid closing costs. Sellers of primary residences may pay a part of the buyer's closing costs, which include the PMI charge. 
Read more about seller paid closing-costs

Single premiums are offered in two forms: refundable and non-refundable.

If the loan is paid off early, the borrower receives a portion of the single payment returned. If the loan is returned early, any earned premium is forfeited with the non-refundable option. The single premium that is non-refundable is less costly.

Down Payment Percentage Loan Amount Credit Score Premium Factor One time payment
3% 194,000 700 3.18% 6,169.20
5% 190,000 700 2.52% 4,788.00
10% 180,000 700 1.75% 3,150.00
15% 170,000 700 0.71% 1,207.00

3. Split premium

The split premium option combines the one-time payment and the monthly premium into a single premium. Borrowers may be required to pay a part of the mortgage insurance upfront in exchange for a reduced monthly payment. The monthly cost is proportional to the initial cost.

Credit score also has an effect on the monthly cost.

Down Payment Percentage Loan Amount Credit Score Upfront Premium Factor Monthly premium factor One time payment Monthly payment
3% 194,000 700 0.50% 1.06% 970.00 171.37
5% 190,000 700 0.50% 0.76% 950.00 120.33
10% 180,000 700 0.50% 0.47% 900.00 70.50
15% 170,000 700 0.50% 0.10% 850.00 14.17

4. Lender paid mortgage insurance (LPMI)

The fourth option is lender-paid mortgage insurance, or LPMI. This option requires the lender to pay a single fee to the mortgage insurance provider and charges the borrower a higher interest rate. This form of payment should be compared against the monthly payment to see which is better. There is a trade-off between a higher interest rate and a decreasing monthly mortgage insurance cost in the future.

  Frequently Asked Questions About PMI & MIP

Q. Can I refinance to remove PMI?
A. Refinancing your mortgage can be a good way to eliminate the PMI, provided that the new loan amount is 80% or less than the home's market value

Q. How Can I Get Rid of PMI?
A. You have the right under The Homeowner's Protection Act to seek the cancellation of your PMI payment if your mortgage amount falls below 80% of the home's original value. When your principle amount exceeds 78 percent of the initial value of your property, the Homeowners Protection Act compels the lender to eliminate the PMI payment.

Additionally, you must have a good payment history, which implies that you have not been 30 days late with your mortgage payment in the year before your request, or 60 days late in the two years preceding your request.

The lender may demand evidence that the property's value has not decreased below its original purchase price and that there is no second mortgage on the property, such as a home equity loan. The Homeowners Protection Act does not apply to VA or FHA loans.

The following table is an approximate estimate of the number of years required to achieve a 20% reduction in PMI costs. This example assumes a $160,000 loan at 80% of a $200,000 sales price.

PMI Loan Amortization Schedule
Sales Price 200,000 200,000 200,000
Down Payment 5% 10% 15%
Loan Amount $190,000 $180,000 $170,000
Payoff in years 8.75 6.58 3.67

Q. How to avoid PMI?
A. Obviously, make a 20% down payment or choose a piggyback loan. With this option, the loan amount is broken up into two mortgages. The first mortgage is calculated at 80% of the sales price and the second mortgage reflects the balance. Here's an example of a loan amount of $100,000:

1st mortgage = $100,000 X 80% = $80,000
2nd mortgage = $100,000 less $80,000 less $10,000 (down payment) = $10,000 (2nd loan)

Q. Is PMI required on FHA loans?
A. Although the words mortgage insurance premium (MIP) and private mortgage insurance (PMI) are often used interchangeably, they are not synonymous. The monthly mortgage payment is used to fund the FHA lending program (MIP).

Unlike PMI, the monthly MIP is permanent, regardless of whether you have a 20% down payment or equity in your house.

The FHA mortgage insurance is only available in monthly installments. The FHA does not utilize credit scores as a premium component, but it does use down payment and mortgage length to determine monthly mortgage insurance costs. The FHA mortgage insurance formula is straightforward. Divide the loan amount by the yearly premium and multiply by 12. (months). For those with poor credit, FHA mortgage insurance is much cheaper.
Read more about the FHA loan program

Q. Why do banks want a 20% down payment?
A. Over the years, the banks have found that when there's at least 20% equity (down payment), they can easily sell the home after foreclosure at 80% of the value of the home.