If you’re a first-time homebuyer, you’ve heard (or will hear about) mortgage insurance (MI). In this post, we will explain what mortgage insurance is and why you need it. We will detail the difference between mortgage insurance premium and private mortgage insurance, as well as the loan products they belong to. Lastly, we’ll cover how to get rid of mortgage insurance all together. It’s really important to know everything about MI since it will most likely make up a portion of your monthly PITI (principal, interest, taxes and insurance) payment, so read on.

There’s no way around it: insurance is required for a mortgage when your down payment on your home is anything less than 20%. Mortgage investors view the down payment as additional evidence that you are financially prepared to take on the debt of a monthly mortgage payment. The larger the down payment, the more you can prove to the investor that you will not be at risk of joining the default statistics.

Mortgage Insurance Premium (MIP) and Private Mortgage Insurance (PMI) pretty much serve the same purpose: to offset the default risk to lenders (your mortgage company) when borrowers (you) have purchased homes with low down payments (below 20%). Mortgage insurance does not protect buyers; it protects lenders from the potential default of buyers. That’s why it’s mandatory.

Before we continue, consider this: don’t let MI scare you. There are many different loan options, scenarios and programs that could work for your specific financial situation. Don’t feel that you have to save 20% to put down to buy a home – it can be as little as 1, 3 or 5 percent depending on what you qualify for. Even though mortgage insurance is part of obtaining a mortgage, it’s often for more affordable than people think whether it’s paid monthly or in a single up-front payment. Always remember that you have options!

There are some significant differences between PMI and MIP. PMI applies to conventional loans with more traditional down payments and protects the lender. MIP applies to FHA government-backed loans. In both cases, the insurance costs are passed on to buyers, but in the case of PMI, the mortgage insurance is supplied by a third party. However, if you can afford to put the standard 20% down payment toward a home, you can avoid mortgage insurance altogether — the best outcome of all. Be sure to consider insurance costs when determining the size of mortgage that you can afford. And not to worry – your licensed RHF loan officer will explain all of this to you.

Private Mortgage Insurance is required on conventional loans with a down payment of less than 20%. However, PMI may offer more flexibility in terms. It can be paid as a lump sum at closing (which means it won’t be added to your payment each month), or financed along with the home and incorporated into monthly mortgage payments (if you prefer to have that cash on hand). PMI amounts vary based on the size of your mortgage loan and your individual risk factors like the loan-to-value ratio (LTV), a measure of how much initial equity you the buyer holds. To calculate your LTV, divide your loan amount by the home’s appraised value or purchase price.

In most cases, PMI must be removed at 78% LTV and borrowers can request that PMI be removed after the LTV ratio reaches 80%.

MIP is a requirement of FHA loans. While conventional loans have more strict underwriting guidelines, FHA loans require a small amount of cash to close a loan and are generally easier to qualify for as they allow for a lower credit score. While there are ways to avoid PMI with conventional loans (by putting a down payment of over 20%), there is no way to avoid MIP on FHA loans because the minimum down payment is only 3.5%.

MIP has two parts: an upfront premium (UFMIP) and an annual premium. The current upfront premium rate is 1.75% of the loan amount, and the current annual premium is 0.85% for most FHA loans. Annual premiums can be lower for lower LTV values or mortgage terms of fifteen years or less. Again, this will be explained to you by your loan officer when they review your personal financial situation as they can advise you what your best options are.

UFMIP is usually financed into your mortgage amount because it does not count against the LTV value that is used to determine other thresholds. That’s generally because many buyers who qualify for and obtain an FHA loan with a low-down payment don’t generally have the cash on hand to pay UFMIP directly.

In order to avoid mortgage insurance, you would need a down payment of over 20% on your mortgage home loan. Another option for avoiding it is to use “piggyback” financing, where a second mortgage is taken out the same time as the first. At RHF, we offer this type of financing. For example, an 80-15-5 would mean your first mortgage is for 80% of the purchase price, the second mortgage is for 15% of the purchase price, and your down payment is 5%, making that 15 plus 5 the 20% needed to avoid mortgage insurance (an LTV of under 80%).

But, most people don’t have that 20% to put down. In that case, once your LTV hits that 80% – you can either a). request your PMI be removed if you’re in a conventional loan; or b). refinance out of your FHA loan (for PMI, once the LTV goes to 78%, it is automatically removed). Although you can cancel PMI with a conventional loan, you cannot cancel FHA MIP. The only way to eliminate FHA insurance is by refinancing into a non-FHA-insured loan. Having a licensed, trustworthy loan officer is incredibly helpful to help you understand all of this and assist you when the time comes to get rid of MI.

When obtaining a mortgage, it’s very important that you find a loan program or product that fits your specific financial situation and goals. At Residential Home Funding Corp., our loan officers spend time looking at your financial situation, your qualifications, and talk with you to give you the best options available for your personal needs.

If you would like to see if you qualify for an FHA Loan, click here.

If you would like to see if you qualify for a Conventional Loan, click here.

Not sure which loan you need? Check out our Home Purchase Qualifier here.

To speak to a licensed Loan Officer in your area, please call (973) 577-7008.