Mortgage protégés are frequently confused between Private Mortgage Insurance (PMI) and Mortgage Insurance Premium (MIP) and I’m regularly asked to differentiate between the two of them. What I explain to them is that, although they’re both forms of mortgage insurance to protect against the borrower defaulting on their mortgage loan, they’re quite different from and should not be confused with each other.
Private Mortgage Insurance (PMI)
Several decades ago, mortgage industry research was conducted that conclusively determined that people who have 20% or more equity in their properties are statistically less likely to default on their mortgage loans when compared to those having less than 20% equity. It was concluded that 20% equity is enough “skin in the game” for a mortgage borrower to want to do anything and everything necessary to protect his or her property against loss through foreclosure.
When this industry research was concluded, the mortgage industry found itself at a fork in the road. On the one hand, they could continue “business as usual” despite the newly-realized risk. On the other hand, they could limit mortgage loan-to-values (LTVs) to 80%. The latter, however, would eliminate significant numbers of people from experiencing the American dream of homeownership. Let’s face it. Not many people have 20% or more to put down when buying a home. So what was the industry to do? Ultimately, a third pathway was forged … the creation of the mortgage insurance industry.
Private mortgage insurance (PMI) is required on just about all conventional mortgage loans when the borrower has less than 20% equity in the property. PMI protects the lenders and investors by insuring them against the borrower’s default. It’s important to understand that PMI does nothing for the borrower. It does not insure against the borrower’s demise, loss of income, or the loss of employment. In fact, it does nothing at all for the borrower aside from allowing him or her to procure a mortgage with less than 20% down.
Several considerations are utilized to determine the PMI factor used for a particular loan. Some of these considerations consist of the loan’s LTV, the borrower’s credit score, the home’s intended use, and the property’s size. Once the factor is determined, the loan amount is multiplied by that factor and the result is divided by 12. That divided amount constitutes the borrower’s monthly PMI premium.
Once a borrower reaches 20% equity in his or her property, he or she may petition his or her mortgage servicer for the PMI’s removal. If the borrower does not, for whatever reason, petition his or her servicer for the PMI’s removal at 80% LTV, the PMI will automatically be removed once the LTV reaches 78% (77% in the case of high-risk mortgages) as long as the loan is current.
The bottom line is that, if a borrower has less than a 20% down payment, unless he or she consents to the acceptance of PMI, he or she will not be granted his or her loan.
Mortgage Insurance Premium (MIP)
In its two forms AMIP and UFMIP, mortgage insurance premium (MIP) is required on just about every FHA mortgage loan. Although similar to conventional PMI in protecting against default, whereas PMI premiums are paid to the PMI company to insure the lender, MIP is paid to the federal government (HUD) to insure lenders of FHA loans.
MIP applies to all FHA loans with the exception of the Reverse Mortgage and the Hawaiian Home Lands Loan. The annual mortgage insurance premium (AMIP) is calculated by multiplying the loan balance by a pre-determined AMIP factor resulting in the annual mortgage insurance premium. The annual mortgage insurance premium is then divided by 12 resulting in the monthly AMIP premium incorporated into the borrower’s periodic payment. This calculation is performed annually so that, as the loan’s balance reduces, so will the AMIP premium.
The upfront mortgage insurance premium (UFMIP) is a one-time premium that gets added directly into the FHA loan. Purchase price minus down payment equals base loan amount. Base loan amount multiplied by the current UFMIP factor of 1.75% results in the upfront mortgage insurance premium. The UFMIP is then added to the base loan amount to arrive at the total FHA loan amount.
Unlike its PMI cousin, AMIP is not automatically eliminated once the borrower’s loan reaches a lower LTV. If the borrower’s original down payment was 10% or more, the AMIP will automatically be removed after the loan’s eleventh year. If, however, the borrower’s down payment was less than 10%, AMIP becomes a life-of-loan requirement. Of course the borrower could always refinance his or her loan once he or she acquires enough equity to avoid conventional PMI, but there is never any guaranty of the borrower’s ability to qualify for another loan at a future time. If the borrower refinances into another FHA loan within the original FHA loan’s first three years, he or she will receive a prorated refund credit towards the new loan’s UFMIP from the previous loan’s UFMIP.
Although it’s never enjoyable to have to pay more fees just to borrow money, PMI and MIP bridge the gap between lenders and borrowers who lack significant funds. Mortgage insurance affords necessary protection to the lenders and the government while accommodating borrowers who lack the funds that would otherwise be necessary to pursue mortgage financing and the American dream of homeownership.