Mortgage Insurance – PMI vs FHA, Which is Better?
A mortgage insurance policy is required anytime you have less than a 20% down payment, or equity, at the time you secure financing for your home.
This mortgage insurance policy protects the lender in the event of a default.
Essentially, you pay the monthly premiums on this insurance policy in exchange for not having to come in with 20% down payment.
I am surprised and a little disappointed that mortgage insurance is one of the most misunderstood benefits of using leverage when getting approved for home loan financing.
One way to think about it is that you are essentially financing your down payment as opposed to coming in with one big chunk of cash.
If you are not buying a home because you’re trying to avoid paying for insurance, you’re delaying homeownership for the wrong reasons.
FHA Mortgage Insurance
Most people call all mortgage insurance PMI. This is not exactly accurate.
Using PMI to describe all mortgage insurance is like saying Kleenex when you’re talking about facial tissue, or Band-Aid when talking about bandages, or Q-Tip when referring to a cotton swab.
FHA is broken down into two parts, a Mortgage Insurance Premium (MIP), and an Up Front Mortgage Insurance Premium (UFMIP).
MIP is calculated as an annual premium that is paid monthly, and added to your mortgage payment. FHA requires that this insurance premium is paid for as long as you have a FHA mortgage.
FHA Historical MIP and UFMIP Chart
Over the years, FHA has made changes to both the UFMIP and the MIP insurance premiums. Here’s the history of FHA MIP, from 2008 to early-2015:
- Prior to January 2008 : 0.50% annual MIP plus 1.50% UFMIP
- October 2008 : 0.55% annual MIP plus 1.75% UFMIP
- April 2010 : 0.55% annual MIP plus 2.25% UFMIP
- October 2010 : 0.90% annual MIP plus 1.00% UFMIP
- April 2011 : 1.15% annual MIP plus 1.00% UFMIP
- April 2012 : 1.25% annual MIP plus 1.75% UFMIP
- April 2013 : 1.35% annual MIP plus 1.75% UFMIP
- January 2015 : 0.85% annual MIP plus 1.75% UFMIP
NOTE: The annual MIP numbers are based on FHA’s minimum equity requirement, which is bringing in a 3.5% down payment, or having 3.5% equity in your home if you are refinancing. The annual MIP is reduced by .05% with a maximum loan to value of 95%.
The up front mortgage insurance premium is almost always financed into the loan amount. Even though you are making a down payment of 3.5%, your loan amount is actually higher than 96.5% loan to value due to the UFMIP being added to the base loan amount.
Pro-Tip: The UFMIP can be paid in full so that it does not get added to your loan balance. There are several ways to do this.
- Take a slightly higher rate and lender credit to pay UFMIP in full*
- Apply seller concessions to pay UFMIP in full*
- Use gift funds to pay UFMIP in full*
* You are not allowed to “partially” pay the UPMIP. It must be paid in full, or financed into the loan entirely.
Conventional Mortgage Insurance
Non-government loans, like Conventional loans underwritten using Fannie Mae or Freddie Mac guidelines, also require a mortgage insurance policy to protect the lender in the event of default.
The rules are the same, if you have less than 20% equity, you’re going to be required to pay the premiums for one of these policies. When you are using a Conventional mortgage, and need mortgage insurance, you are going to use a Private Mortgage Insurance (PMI) policy.
Private mortgage insurance works much differently from FHA mortgage insurance. Other than the 20% equity rule, there are very few similarities between Conventional PMI and FHA, Government provided mortgage insurance.
With PMI, you only have an Annual mortgage insurance premium, and no UFMIP like you do with FHA financing.
Different Types of Private Mortgage Insurance (PMI)
Not all of these types of PMI are available, but they have been available in the past, and may again be available in the future:
Split Premium – Similar to FHA MIP, split premium PMI splits the annual mortgage insurance premium into an upfront amount that can financed into the loan amount, with the remainder being paid as part of your monthly mortgage insurance.
Single Premium – An up-front premium calculated as a percentage of the total loan amount that is paid entirely at the close of escrow. Depending on your credit score and the loan to value, this “buy-out” premium will typically cost you 3% or more of the loan amount.
Lender Paid – This is a very popular option for borrowers with higher credit scores. Lender paid private mortgage insurance essentially takes the cost of buying out your mortgage insurance similar to single premium, and converts that to a “cost”.
Instead of covering this “cost” out of pocket, the lender will roll the premium into the interest rate, resulting in a higher interest rate. The real benefit of this strategy is to convert PMI, which is normally not tax deductible, into mortgage interest, which is tax deductible.
Borrower Paid – FHA mortgage insurance is borrower paid. This simply means that the annual premium is paid monthly, as part of your mortgage payment.
FHA vs Conventional – Which is Better?
Unlike FHA MIP, Conventional PMI will increase or decrease depending on what your loan to value is at the time of financing. FHA only offers 1 opportunity to discount MIP, that’s by putting 5% down, instead of 3.5% down (or having 5% equity if you are refinancing).
One of the biggest differences between MIP and PMI is that your credit score and loan to value contribute much more to the cost of your mortgage insurance policy premium with PMI (Conventional financing) than it does with MIP (FHA financing).
When comparing both FHA and Conventional mortgage insurance options with a 5% down payment, you have to have a minimum 740 FICO before your PMI premium is lower than FHA MIP.
Here’s an example of a scenario comparing both options, with 5% down payment (or equity if refinance), and a minimum 620 credit score. As you can see, with similar loan to value (95%), and the only difference being the credit score, PMI is over twice the cost of FHA MIP.
Now let’s look at the same scenario as above, except that you have a 15% down payment. This is a 85% loan to value home loan, and a perfect example of how Conventional PMI is very attractive if you have more than the minimum down payment or equity.
The answer to the question, which is better “MIP or PMI” depends entirely on your credit score and the loan amount compared to the value of the property at the time of refinance.
An experienced loan officer should be able to help you identify the best option for you at the time of application for the new loan. An inexperienced loan officer most likely will not have the discussion with you about which option is better, they will just tell you about “one” option.
There are many moving parts when if comes to qualifying for the best home loan options. In the cases of working with an inexperienced loan officer, your options are limited to the loan officer’s understanding of your options.
Working with an experienced loan officer is not only going to help you save money, but it will also empower you with the ability to make an informed decision about the best option for you, by considering ALL of your options.