Disclaimer: The statements made in this post are the opinion of the author. They should not be viewed as financial advice. Please consult with a financial specialist before making any financial decisions.
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Buying a house is a very big decision. Most people, including myself when I first started, make the decision too lightly.
One of the things to consider when you are buying a home is how much your final monthly payment will actually be.
This final amount is how much principal and interest you pay each month, property taxes paid into escrow, home insurance paid into escrow, any HOA fees you may have, and mortgage insurance.
Mortgage insurance comes in different varieties called PMI and MIP. Understanding this will help you make the best decision when buying a home.
What Is PMI and MIP?
Before we dive into PMI and MIP it is important to understand what mortgage insurance is in general. Mortgage insurance is a monthly payment on top of the principal/interest paid to the bank that helps them feel comfortable loaning to a “risky” buyer. It is insurance against a buyer defaulting on a loan.
The most common reason to pay mortgage insurance is because you haven’t put down 20% on the loan. The bank views this as risky because you don’t have enough skin in the game or enough equity built up in the property.
Most people can wrap their head around the basic idea of mortgage insurance I’ve just outlined, but then like most jargony industries the banks have to go and confuse us with acronyms.
The two we will worry about today are PMI and MIP.
PMI – Private Mortgage Insurance
It really doesn’t help the two acronyms use the same letters in a different order. PMI stands for private mortgage insurance. Because it is private insurance that means that it is offered through a company that is insuring the loan.
PMI is paid on conventional loans where the borrower puts down less than 20%.
MIP – Mortgage Insurance Premium
Mortgage Insurance Premium or MIP on the other hand is specific to the FHA (Federal Housing Administration) so it is a government backed program. The MIP basically works the same way as the PMI but the government agency is collecting the funds to offset their risk of backing the loan.
MIP is specifically for FHA loans which almost always are used for buying a home with less than 20% down.
(I don’t know any examples of using an FHA loan and putting 20% down, but I guess they could be out there).
Major Difference Between PMI and MIP
Despite being basically the same thing there are a few major differences between PMI and MIP.
Pay Off Up Front
- PMI: You can pay the entire amount of PMI upfront at closing to avoid paying monthly.
- MIP: You can only pay the monthly premium, no up front pay off is available.
- PMI: You are not charged anything upfront for PMI.
- MIP: You are charged 1.75% of the loan amount in MIP upfront (which can be rolled into the loan).
When Paid Off
- PMI: You can request your PMI be removed when you reach 20% in equity on your property, and it is automatically cancelled at 22% (in most cases).
- MIP: You pay MIP for the life of the loan. You’d have to refinance the loan to a conventional loan when you reach 20% equity to stop paying MIP.
Questions You May Have About PMI/MIP
The main differences are the meat of the topic PMI vs MIP, but there are other questions you may have about them. Below are the most frequently asked questions and a few things to consider when buying a house with PMI or MIP.
Do You Have To Pay Both PMI and MIP?
The short answer to this question is no.
PMI is only used for private mortgages (those not backed by the federal government). MIP on the other hand is for FHA loans. It is impossible to have a conventional mortgage and an FHA mortgage on the same property, so you won’t pay both.
The only way you’d pay both PMI and MIP is if you owned one property with a conventional mortgage under 20% equity and another property with an FHA mortgage under 20% equity.
Which Is Cheaper PMI or MIP?
This question is all but impossible to answer. While MIP has strict guidelines on the percentage you pay based on how much equity you have in the mortgage, PMI is much more flexible. Rates change depending on equity in the property, the applicant’s credit score, the loan term, and a few other things.
If you’re contemplating getting a mortgage that requires PMI or MIP talk to your loan officer about which would be better in your situation.
Is PMI/MIP Tax Deductible?
Let me first say that I am not a CPA. With that said, mortgage insurance is not in general tax deductible (although there are some provisions in place that can allow it to be tax deductible). These situations are things you’d need to ask a CPA about.
Something to keep in mind, however, is that the standard tax deduction is $12,550 for singles and $24,800 for married couples in 2021. So unless you’ve had more than that in tax deductible expenses this point doesn’t matter anyway.
Does PMI/MIP Go Down Every Year?
The short answer is no.
Like pretty much every insurance it does not go down from year to year. However, unlike most insurances they don’t usually increase from year to year. If you have a 30 year fixed rate mortgage your PMI/MIP payment should not change until you reach 20% equity and it goes away or you refinance out of the mortgage to eliminate MIP.
There are circumstances where your insurance payment could increase and there are times when you can request a decrease. These actions are regulated.
Do You Never Get Your PMI/MIP Money Back?
The answer is once that money is paid it is paid. It isn’t held in escrow and given back when you pay the entire mortgage. That money is an insurance premium just like your car insurance or your life insurance. That money is gone.
Is It Better To Pay PMI Upfront Or Monthly?
So to clarify, you cannot pay MIP upfront. It can only be paid monthly. PMI, on the other hand, can be paid up front.
Usually it isn’t any cheaper to pay PMI upfront, you still pay the full amount you would. By paying it upfront you are actually taking on some risk because if you sell the house or refinance you will lose that money that you paid upfront.
The best way to reduce your PMI costs is not to pay it upfront but to make additional payments on your mortgage to get up to 20% equity sooner. Once you’ve reached 20% equity (regardless of how many months you’ve had the mortgage) you can cancel the PMI so the more you pay in principal early on the more you save in PMI (and interest) upfront.
That doesn’t mean everyone should pay their mortgage upfront, but it is a consideration, especially if you have a PMI payment.
Should I Put Down 20% Or Pay PMI?
As with most financial decisions it depends. So let me give you the tools to make a decision.
Reasons to put 20% down
- You have the money. This may seem super obvious, but I would recommend against putting 20% down if you have to scrape it together. Wait until you can comfortably put down 20%.
2. You want to pay less in interest and fees. With less money loaned you will pay less in interest. So if paying someone else interest irks you then you’ll want to put 20% down.
3. You are struggling to qualify. The more money you put down the easier it becomes to qualify. People often think of an FHA loan as the easy way into home ownership, but it has a lot of rules. If you have low credit or are self employed then putting more money down is probably better.
Reasons to pay PMI/MIP
- It would take too long to save up for a 20% down payment. If you have a job that let’s you get by but saving for a down payment (especially with high rent prices) is all but impossible then PMI/MIP is a great tool to get into home ownership. But if the reason you can’t afford a down payment is lack of budgeting on your part then consider changing your finances before you make the decision to buy a home.
2. You need the down payment money for other investments. If you can pay $60 a month in PMI, but get $100 a month with your 20% down payment money being invested then mathematically speaking it is the best option to pay the PMI because you come out with more money in the end.
3. You live in a very expensive market. Sometimes saving up 20% isn’t feasible even for those that make a lot of money. If the cheapest homes where you live cost half a million then your down payment at 20% will be $100,000. With other high costs in these markets saving that much money can seem impossible. But saving $17,500 for a 3.5% down payment is possible. So if the only way you can get into a home is by paying PMI, then that might be a good option.
Please note that these are considerations for buying a home but it doesn’t take into account whether or not you should buy a home. In some cases buying a home is not best for you. So please consider whether or not you should buy a house before you weigh how much you should put down on the house.
How Do I Get Rid Of MIP?
Unfortunately, MIP doesn’t just go away. Part of the deal with getting an FHA loan is that the MIP is attached to it for the life of the loan. So if you keep an FHA loan for 30 years you will pay MIP for 30 years.
That being said, FHA loans are supposed to help people get into houses, but they aren’t intended to be full term loans. At least, not according to most loan officers.
There is no hard and fast rule for how long it will take to reach 20% equity on the property, but for a $250,000 loan at 4.5% interest with 3.5% down it will take you almost 9 years to reach 20% equity by making the minimum payments.
That is a long time, but getting ride of MIP will make refinancing well worth it.
Here are a few things to consider. The more money you pay upfront the faster you’ll get to 20% equity assuming your bank is putting your money towards the principal and not the interest (double check that).
Another thing to consider is getting an appraisal before then. If you are reasonably sure that your home has significantly appreciated in value it is possible to get an appraisal as part of a refinance and to use that new value to measure how much equity you have.
So let’s say that your house was bought for $100,000 and you paid 3.5% so you owe $96,500. The next year let’s say it appraises at $110,000 (not an entirely unreasonable jump). Without considering the pay down over that first year you’d already have a 10ish% jump in equity.
Lastly, when you choose to refinance, you need to realize that in most cases that means your 30 year term will restart. That means your interest count down restarts (you pay more interest upfront again), and it is really the worst part of refinancing. Consider asking your loan officer about refinance options that will avoid that restart, or reducing the term amount to 20 years if it took you 9 years to get to 20% equity.
Mortgage Insurance Summary
Mortgage insurance is neither good or bad. It is just a tool to be used in very particular situations.
The intention of mortgage insurance is to protect the lender while helping people getting into home ownership faster. There are unintended consequences though.
It is very possible to get into a home that you can’t afford by paying a low down payment. Don’t fall into that trap.
Will you use mortgage insurance on your next purchase? Do you think it should always be avoided or is a useful tool? Tell me about it in the comments below.
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A list of definitions used on this blog can be found here.
Mortgage Insurance: A monthly payment on top of the principal/interest paid to the bank that helps them feel comfortable loaning to a “risky” buyer. It is insurance against a buyer defaulting on a loan.
Equity (Housing): How much your property is worth versus how much you owe on it. So if your property could sell for $100,000 and you owe $40,000 then you have $60,000 of equity.