While both private mortgage insurance (PMI) and FHA insurance provide lenders with a way to reduce the risk on a mortgage with a low down payment, they work differently when it comes to cancellation and reducing borrower fees. Most FHA mortgage insurance cannot be removed unless you refinance, while borrowers paying PMI on conventional mortgages can eliminate those costs once they reach a certain level of equity.
- FHA Premiums vs. PMI: What's the Difference?
- What Do PMI and FHA Insurance Cost?
- Removing PMI or FHA Mortgage Insurance
FHA Premiums vs. PMI: What's the Difference?
FHA mortgage insurance premiums, often referred to as MIP, are set by the Federal Housing Administration at different rates depending on the borrower's loan-to-value ratio. Private mortgage insurance (PMI) applies to conventional loans obtained from a bank or direct lender, so costs can vary depending on where you shop.
|FHA Mortgage Insurance||Private Mortgage Insurance|
Because FHA loans allow for much smaller down payments, they carry major disadvantages in their insurance costs. Lower down payments mean greater risk to the lender, so the FHA requires both an upfront mortgage premium (UFMIP) in addition to ongoing premiums. While FHA premiums do shrink slightly as you make more payments, you'll have to wait at least 11 years to eliminate them completely. If your original down payment was under 10%, you won't be able to eliminate MIP at all unless you refinance into a conventional mortgage.
Private mortgage insurance (PMI) is insurance which covers the mortgage lender in case the borrower defaults on repaying the mortgage. As a borrower, you must pay a PMI premium if you're in a conventional mortgage and have less than 19% equity in your home. PMI can be cancelled if your original down payment is at least 20% or if you make enough payments, which means that FHA borrowers can refinance into a conventional loan in order to eliminate mortgage insurance.
What Do PMI and FHA Insurance Cost?
With none of the upfront payments involved in FHA mortgage insurance, private mortgage insurance policies are almost always cheaper than FHA plans. To illustrate the potential differences for an actual mortgage, we calculated the insurance costs of a conventional mortgage and an FHA loan for identical loans.
30-Year Mortgage Insurance Costs: FHA vs. PMI
|FHA Mortgage Insurance Premiums (MIP)||Private Mortgage Insurance (PMI)|
|Years Before Removal||11y||5y 4m|
|Total Mortgage Insurance Costs||$18,990||$5,184|
For a home purchase price of $200,000 and down payment of 10%, we found that you would pay almost four times as much in mortgage insurance with an FHA loan compared to a typical PMI premium of 0.76%. While all FHA borrowers must pay the 1.75% upfront premium (UFMIP) at closing, the FHA sets different rates for annual premiums depending on your term length, loan amount and down payment. While the UFMIP contributes to the difference, the greatest disadvantage of FHA mortgage insurance is that you must pay monthly premiums for almost twice as long as you would with a conventional mortgage.
Although the difference in lifetime costs may seem dramatic, it's important to keep in mind that FHA loans are aimed at borrowers who would have trouble getting approved for a conventional mortgage from a private lender. FHA mortgage insurance may run high compared to PMI, but if you don't have enough money saved to qualify elsewhere, the FHA can be a good place to start. Once you've grown your equity in the house through regular payments, you can start considering a refinance. This will allow you to move from an FHA loan to a conventional mortgage, shedding your FHA mortgage insurance in the process.
Removing PMI or FHA Mortgage Insurance
Removing FHA insurance is one of the major ways you can save money on your mortgage, but in many cases you'll have to refinance into a different mortgage to eliminate your premiums. If you started an FHA mortgage in 2013 or later with less than 10% in down payment, then you won't be able to remove mortgage insurance unless you refinance out of the FHA loan program. Mortgages originated before 2013 or with at least 10% down can have insurance premiums removed after 11 years.
PMI removal, on the other hand, varies by lender. As a general rule, you'll need to reduce your LTV ratio to 81% before lenders will consider your request to have mortgage insurance removed. The law requires all mortgage lenders to drop premiums automatically once a borrower gets down to an LTV ratio of 78%. The time it takes you to reach that threshold will depend on your amortization schedule and your initial down payment. For example, the 30-year mortgage we used in the example above would reach 81% LTV in 5 years and 4 months, assuming a down payment of 10%.
|Down Payment||Years of Required PMI||Minimum Number of Premium Payments|