Mortgage insurance is a typical requirement for borrowers with a down payment of less than 20 percent on their home. Because these borrowers are viewed as higher risk, mortgage lenders ask for additional insurance to cover monthly payments in the event of default. The type of mortgage insurance you pay will depend on your loan type. Conventional mortgages carry private mortgage insurance, also known as PMI, while Federal Housing Administration (FHA) loans are insured though a mortgage insurance premium (MIP).
Private mortgage insurance
Homebuyers seeking a conventional mortgage under the parameters of Fannie Mae or Freddie Mac will most likely be asked to obtain private mortgage insurance if they do not have a 20 percent down payment. To qualify for a conventional mortgage, you must provide at least a 5 percent down payment. Private mortgage insurance premiums are often based on a percentage balance of the total mortgage loan. Your credit score may also be a factor in your premium. The projected cost of your PMI will be listed on the good faith estimate provided by your mortgage lender. Although PMI is an added expense that raises your monthly payment, this extra cost may be worthwhile for homeowners with a lower down payment who wish to take advantage of today’s lower interest rates.
Borrowers with lower credit scores and a down payment of less than 5 percent (as little as 3.5 percent) who have FHA loans pay insurance through the mortgage insurance premium (MIP) policy. To encourage lenders to accept borrowers outside of the conventional loan parameters, the FHA insures the loans through its own separate mortgage insurance program. Depending on your loan size and term, you may pay an upfront fee for MIP, calculated as a percentage of the mortgage amount. This MIP increases the total amount borrowed by the homeowner. Other FHA loans may charge a monthly MIP in addition to your loan payment.
Eliminating mortgage insurance
One important difference between PMI and MIP is the ability to cancel mortgage insurance. If you have PMI, you may request that the insurance be discontinued when your mortgage balance falls to 80 percent of your home’s value. At this point, your mortgage lender may request an appraisal, at your expense. The other option for removing PMI is to simply wait until your principal value falls to 78 percent, at which time the PMI will automatically be removed. Conversely, the FHA requires MIP for the life of the loan, notes Bankrate. To drop the insurance, you would need to refinance to a conventional loan.
Mortgage insurance stipulations are not often the sole deciding factor when choosing between FHA or conventional loans. Yet, combined with other loan features such as down payment requirements, the cost of mortgage insurance should be considered with calculating your monthly housing payment. Your lender can help you navigate through this process and determine the best type of loan for you.
Image source: Flickr