Let’s talk about why mortgage insurance exists. When you get a mortgage, a lender gives you the money needed to buy your house. These lenders need to protect their investment in case you can’t make your monthly payments (or, “default”). That’s why they require homeowners to purchase mortgage insurance.
Mortgage insurance exists to protect the lender, not the homeowner.
Mortgage insurance is often paid monthly through a mortgage escrow account. It’s one of the four things most homeowners pay for each month:
- Principal amount borrowed from the lender
- Interest on what was borrowed
- Property taxes
- Mortgage insurance
“Mortgage insurance exists to protect the lender, not the homeowner.”
The Differences Between MIP and PMI Insurance
There are two different types of insurance on your mortgage: MIP and PMI. While they sound similar, they serve very different purposes.
When is MIP required?
A mortgage insurance premium (MIP) is used specifically for one type of mortgage: FHA loans. FHA loans are popular for first-time homebuyers because the down payment requirement is only 3.5%. However, this low down payment requires some trade-offs. One of the tradeoffs is the requirement of MIP.
MIP may eventually be removed from an FHA loan in some cases. This removal depends on when your loan started, the size of your down payment, and your current loan-to-value ratio.
Most FHA borrowers will be responsible for paying MIP throughout the life of their loan.
When is PMI required?
Private mortgage insurance(PMI) is required when you apply for a conventional loan and put less than 20% down on the house. Why twenty percent?
From the perspective of the investor (Freddie Mac, Fannie Mae, and others), a 20% down payment shows that a homebuyer is financially secure and has enough equity in the house to help ensure they continue making payments.
If you put less than 20% down, you’ll continue to pay PMI until you reach that 20% equity threshold. At that point, you can request that PMI be removed from your mortgage payment if you’ve demonstrated good payment history.
How to avoid MIP and PMI
Mortgage insurance allows you to buy a home even when you’re not able to make a 20% down payment. But, you obviously don’t want to pay for mortgage insurance if you don’t have to.
For borrowers with good credit and cash to put down on a house, a conventional loan has several advantages that should be considered:
- Lower interest rates
- Fewer fees
- Choice between an adjustable-rate mortgage & a fixed-rate mortgage
- The ability to avoid mortgage insurance completely
Have more questions?
We understand that getting a home loan can be confusing. These two acronyms alone took some explaining. At The Wood Group of Fairway, we’re happy to help you navigate the homebuying process and answer all of your questions along the way.