Private Mortgage Insurance (PMI) vs. Mortgage Insurance Premium (MIP): Full Comparison
What You Should Know
- PMI and MIP are paid by the borrowers and protect the lenders in case of default, but PMI is used for conventional loans while MIP is used for FHA loans.
- Even though it is possible to compare PMI and MIP, the loans that they are applied to should also be accounted for when deciding on the best loan option.
- The key differences between MIP and PMI are in their upfront premium, annual premium, and term structure.
The Basics of Mortgage Insurance
Mortgage insurance is a specific type of insurance paid by borrowers and protects lenders if the borrower defaults. Usually, mortgage insurance requires a borrower to pay a certain percentage of the outstanding principal on their loan to protect the lender in case of default. The borrowers choose to pay for this insurance when they are looking to get a loan that may be considered risky by the lenders. For example, conventional loans that have a loan-to-value ratio over 80%, require the borrowers to get private mortgage insurance because mortgage loans with a down payment of less than 20% are considered risky.
Every mortgage type has different mortgage insurance requirements, costs, and conditions. This means that a borrower should consider how mortgage insurance will affect their loan when choosing between different mortgage types. The most popular mortgage loans taken in the US are conventional loans and government-backed FHA loans. Both of these loans may require mortgage insurance in some cases, but the mortgage insurance applied to these types of loans is different from each other. Understanding the difference between private mortgage insurance that is used for conventional loans and mortgage insurance premiums that are paid for FHA loans may allow the borrower to choose the financing option that fits their financial situation best.
| MIP vs PMI | ||
|---|---|---|
| Category | MIP | PMI |
| Used for | FHA Loans | Conventional Loans |
| Upfront fee | 1.75% | 0% |
| Annual Fee | 0.45% - 1.05% | 0.50% - 2.00% |
| Term Structure | Down Payment < 10%: Full Term Down Payment ≥ 10%: 11 Years | Until LTV ≤ 80% |
| Tax Deductible | Yes, up to Tax Year 2021 | Yes, up to Tax Year 2021 |
PMI for Conventional Loans
Private mortgage insurance, which is also known as PMI, is mortgage insurance that is used for conventional loans. Conventional loans are issued by many lenders, and they are not backed by the US government. This means that the lenders issuing conventional loans also take on the risks of default by the borrower. The risks associated with conventional loans are related to the borrower defaulting on their loan, and even though mortgage loans use the underlying properties as collateral, the foreclosure process is long and costly for the borrower and the lender. In addition to the costly process, it is possible that the borrower may not be able to recover the outstanding mortgage balance if the property does not have enough buyers. To avoid losing principal on the loan, private insurance companies issue private mortgage insurance that is paid by borrowers and protects lenders in the event of default.
| Conventional PMI Characteristics | |
|---|---|
| Fee Structure | Annual: 0.5% - 2% of Outstanding Principal |
| Term Structure | Automatic Cancellation: at LTV ≤ 78% Manual Cancellation: at LTV ≤ 80% |
| Is It Tax Deductible? | Yes, it is tax deductible for tax years 2018 - 2021. |
PMI is usually required for conventional loans that have a loan-to-value (LTV) ratio of more than 80%. A loan may have an LTV ratio over 80% if the borrower makes a down payment of less than 20% or if the property has fallen in value drastically shortly after the loan origination. A borrower who is required to get PMI should expect to pay an annual fee of 0.5% to 2% of the outstanding principal until their LTV ratio lowers to 80%. A borrower should always try to estimate PMI before choosing to apply for a particular conventional loan because it can make a significant difference over time. Generally, a borrower should avoid paying for PMI because it does not benefit them. If they are required to pay for PMI, they should learn how to remove PMI as soon as possible to potentially save thousands of dollars.
MIP for FHA Loans
FHA loans do not require private insurance agencies to provide mortgage insurance. Instead, the mortgage insurance is priced into the mortgage loan, so the Federal Housing Administration plays the role of the lender and the insurer. FHA loans are backed by the Federal Housing Administration. Since these loans are issued and insured by the same agency, the rules for the FHA loan as well as the insurance differ from the rules for a conventional mortgage.
| FHA MIP Characteristics | |
|---|---|
| Fee Structure | Upfront: 1.75% of Original Principal Annual: 0.45% - 1.05% of Outstanding Principal |
| Term Structure | Down Payment < 10%: Full Term Down Payment ≥ 10%: 11 Years Until Cancellation |
| Is It Tax Deductible? | Yes, it is tax deductible for tax years 2018 - 2021. |
An important distinction of the mortgage insurance premium structure on FHA loans is that it requires two types of payments. FHA loans charge an upfront mortgage insurance premium (UFMIP), and they also charge an annual mortgage insurance premium (MIP). The UFMIP is set at 1.75% of the principal amount for all borrowers while MIP may vary depending on the borrower’s risk profile. MIP ranges from 0.45% to 1.05% depending on the loan-to-value ratio. In addition to that, most FHA loans account for MIP throughout the lifetime of the loan. Only borrowers who make a down payment of at least 10% on their FHA loan, have to pay MIP for 11 years.
PMI vs MIP
PMI and MIP are similar concepts that are applied to different mortgage loans. Even though they are similar in their purpose, they have key differences, such as fee structure and term structure. These differences may be large enough for some borrowers to strongly prefer one loan to another. Understanding how PMI and MIP are different may help a borrower to save money down the road although it is best to compare PMI and MIP in conjunction with the applicable loans. Even though a borrower should compare both with the respective terms of respective loans, there are still three key differences between the two mortgage insurances that a borrower should be aware of.
Upfront Premium: The most immediate difference between PMI and MIP that a borrower may notice is the fact that mortgage insurance on an FHA loan has an upfront fee, called UFMIP. This upfront premium is paid at the time of FHA loan origination, and it is equal to 1.75% of the original principal of the loan. To compare, private mortgage insurance does not require an upfront premium, which also can be interpreted that the upfront premium for PMI equals 0%. This does not mean that PMI is better or cheaper than the MIP because there are other factors and costs to consider.
Annual Premium: Both PMI and MIP have annual premiums that vary based on the borrower. Generally, the annual premium for private mortgage insurance ranges from 0.5% to 2% for most borrowers who require PMI. On the other hand, there are some extreme cases where PMI can be as low as 0.2% and as high as 5% of the outstanding principal. There are various risk factors considered by insurers when issuing private mortgage insurance. When it comes to FHA, the annual MIP is based on the down payment amount, loan term, and loan principal. MIP can range from 0.45% to 0.95% for FHA loans shorter than 15 years. and from 0.80% to 1.05% for FHA loans longer than 15 years. Even though it seems like MIP is cheaper than PMI, term structure also plays an important role in the total cost of mortgage insurance.
Term Structure: The largest difference between the two mortgage insurances is how long a borrower has to pay for the insurance. Conventional loans require borrowers to pay for PMI as long as their LTV ratio is above 80%. As soon as their LTV ratio drops below 80%, the borrowers can cancel PMI manually. If they do not cancel PMI manually, it cancels automatically once the LTV drops below 78%. On the other hand, FHA loans with a down payment of less than 10% require an FHA mortgage insurance premium to be paid throughout the loan lifetime. This means that FHA loans with a down payment of less than 10% will have to pay MIP up until their LTV ratio is 0%. FHA loans with a down payment above 10% will have to pay MIP for 11 years regardless of their LTV ratio.
Is Mortgage Insurance Tax Deductible?
Many people may think that PMI and MIP are different products that may have different tax implications. They are the same when it comes to taxes because both of them fall under the definition of mortgage insurance, so they are treated the way. The Further Consolidated Appropriations Act issued in 2020 permits mortgage insurance tax deductions as itemized deductions for the tax years from 2018 to 2021. Both PMI and MIP are tax deductible under the aforementioned act.