Some loans require a mortgage insurance premium that can increase your mortgage payment and affect your budget. Understanding who needs to pay mortgage insurance and why is important.
If you borrow an FHA loan, you’ll pay mortgage insurance premiums for the life of the loan. But, if you borrow a conventional loan, you might not pay insurance premiums for as long.
Here’s everything you must know about mortgage insurance on mortgage loans.
You likely have heard this word before, but what exactly is MIP and how does it apply to a mortgage?
MIP stands for Mortgage Insurance Premium or in the case of conventional loans, it’s called Private Mortgage Insurance (PMI).
The premise is the same – you must pay an insurance premium that protects lenders, not you, from a loan default. The lender can file a claim against the insurance and get a mortgage insurance disbursement to cover the money they lost when you stopped making payments.
Mortgage insurance is required on many loans to decrease the risk to the lender. You are responsible for all payments, and they’re included in your mortgage payment.
Does Everyone Pay a Mortgage Insurance Premium?
All FHA borrowers must pay mortgage insurance. It’s a stipulation of the loan program.
But mortgage insurance isn’t all that bad. Without it, you might not qualify for a mortgage, so in that case, you might willingly pay for it. FHA loans have the most flexible underwriting guidelines out of any loan program, so paying MIP is really a benefit, not a burden.
The mortgage insurance premium is just for FHA loans. These are loans backed by the FHA which means if you default, the FHA insurance covers the lender by providing a mortgage insurance disbursement. This allows lenders to offer low down payments and accept low credit scores and still qualify you for a loan. This is why mortgage insurance premiums can be considered good.
However, you should know that if you borrow an FHA loan, you’ll pay annual MIP for the life of the loan unless you refinance into a conventional loan. MIP on FHA loans cannot be canceled.
How Do Mortgage Insurance Premiums Work?
Mortgage insurance premiums have two parts – upfront MIP and annual MIP.
- Upfront MIP is equal to 1.75% of the amount you borrow and you pay it at the closing. It’s equal to $1,750 for every $100,000 you borrow, and all FHA borrowers pay it.
- Annual MIP is the insurance premium you owe based on your average annual balance (it decreases each year). It’s equal to 0.85% of the outstanding loan amount, but the payments are broken down into 12 monthly installments.
MIP vs. PMI: What Are the Differences?
Up to this point, we’ve focused on the mortgage insurance premium for FHA loans. PMI is also a commonly paid mortgage insurance, but again, it’s for conventional loans.
PMI works much differently than MIP, so it’s important to understand the differences.
- Borrowers only pay PMI if they put down less than 20% on a home
- Lenders must automatically cancel PMI when the borrower owes 78% or less of the property’s original appraised value
- Borrowers can request cancellation of PMI when they owe 80% or less of the original appraised value OR the current value if they can prove it with a new appraisal
- PMI doesn’t have an upfront charge
- PMI rates are based on your credit score, LTV, and loan term
If you have good credit and a low debt ratio, you might consider a conventional loan even if you don’t have 20% to put down on it. You’ll pay PMI until you pay the loan balance down to 80% of the home’s value, but with good credit, the premiums are typically affordable.
Is It Possible to Cancel Your Mortgage Insurance Premium?
You cannot cancel your mortgage insurance premium on an FHA loan. All borrowers pay the premiums for the life of the loan.
However, to get out of it, you have a few options:
- Refinance the loan into a conventional loan when you owe less than 80% of the home’s value as long as you have good credit and a low debt-to-income ratio.
- Refinance your loan into a first and second mortgage. As long as the first mortgage doesn’t exceed 80% of the home’s value, you won’t pay PMI.
- Refinance into a conventional loan even if you owe more than 80% of the home’s value, but request PMI cancellation when you lower the balance to less than 80% of the home’s value.
The Exceptions to the Rule
There are a few exceptions to the rule that might pertain to you:
- If you don’t pay your balance down to 78% or less of the home’s value by the loan’s midpoint (15 years for a 30-year loan), the lender must automatically cancel PMI.
- The LTV must be 75% or less if you request to cancel PMI within the first 2 to 5 years of taking out the loan due to increased home values or extra payments you’ve made.
If you don’t qualify for a conventional loan with at least 20% down, you’ll likely need FHA financing and will pay the mortgage insurance premium required.
Think of MIP as a way to help you get the loan you need for the home of your dreams. Without it, lenders would need much stricter underwriting requirements which might make it harder to qualify for a loan. Even if you qualify for a conventional loan, though, you’ll likely pay PMI unless you have a large down payment.
Either way, the premiums help you get approved and there are ways to work around paying them for the life of the loan once you are in your dream home.