What's the difference between private mortgage insurance (PMI) and mortgage insurance premium (MIP)?
Private mortgage insurance and mortgage insurance premium sound and act similar, but they are applied to different types of loans.
Private Mortgage Insurance
Private mortgage insurance (PMI) is an insurance policy used in conventional loans that protects lenders from the risk of default and foreclosure, and allows buyers who cannot make a significant down payment (or those who choose not to) to obtain mortgage financing at affordable rates. If you purchase a home and put down less than 20%, your lender will minimize its risk by requiring you to buy insurance from a PMI company prior to signing off on the loan. The cost you pay for PMI varies depending on the size of the down payment and loan, but typically runs about 0.5% to 1% of the loan.
If you have monthly PMI (borrower paid), you make a premium payment every month until:
Your PMI is terminated when your loan balance is scheduled to reach 78% of the original value of your home;
Your PMI is canceled at your request because your equity in the home reaches 20% of the purchase price or appraised value (your lender will approve a PMI cancellation only if you have adequate equity and have a good payment history); or
when you reach the midpoint of the amortization period (a 30-year loan, for example, would reach the midpoint after 15 years).
Other types of PMI include single premium PMI, where you pay the mortgage insurance premium in a single lump sum at closing or finance it into the mortgage, and lender-paid PMI (LPMI), where the cost of the PMI is included in the mortgage interest rate for the life of the loan. (For related reading, see: 6 Reasons to Avoid Private Mortgage Insurance.)
Mortgage Insurance Premium
Mortgage insurance premium (MIP), on the other hand, is an insurance policy used with FHA loans if your down payment is less than 20%. The FHA assesses either an upfront MIP (UFMIP) at the time of closing or an annual MIP that is calculated every year and paid in 12 installments. The rate you pay for annual MIP depends on the length of the loan and the loan-to-value ratio (LTV ratio). If the loan balance exceeds $625,500, you'll owe a higher percentage.
For loans with FHA case numbers assigned before June 3, 2013, FHA requires you to make your monthly MIP payments for a full five years before MIP can be dropped if your loan term is greater than 15 years, and MIP can be dropped only if the loan balance reaches 78% of the home's purchase price. If your FHA loan originated after June 2013, however, different rules apply. If your original LTV is 90% or less, you'll pay MIP for 11 years. If your LTV is greater than 90%, you'll pay MIP throughout the life of the loan. (For related reading, see: FHA Loan: Basics and Requirements.)
The answer by Jean Folger gives you an excellent overview of mortgage insurance. Foreclosure and default are the two events against which the lender needs to be protected. I'll add a third event for which they commonly want insurance: the unfortunate death of the borrower.
Banks don't want to have to chase grieving widows - or widowers - for money when their spouse tragically dies. They often want you to take out life insurance so the surviving spouse can pay off the loan. It typically is not mandatory, but is encouraged.
Today, many banks are in the life insurance business and hire people to sell this product. The policy is often term insurance that mirrors the performance of the loan. The face amount decreases as you make payments.
This seems like an excellent concept; however, in 25 years of selling life insurance, I have yet to see a decreasing term policy that is less expensive than a level term policy. It's just not competitively designed, and many carriers don't carry it any more.
If it is your goal to equip your family or your business with the money needed to be debt-free should they lose you, then get prequalified for coverage and find the carrier that will give you the best underwriting available. This way, you won't have to spend a dime more than you have to on your policy.
Please feel free to contact me with further questions.