Conventional PMI vs. FHA MIP: What’s the Difference?

Most borrowers choose between private mortgage insurance on a conventional loan, known as PMI, and the FHA’s brand of coverage, MIP. Each has advantages and disadvantages.

What Is Mortgage Insurance?

Mortgage insurance protects lenders from losing money if the borrower stops making payments and defaults on their mortgage.

This coverage protects the lender, but the borrower pays for it through mortgage insurance premiums—a fee added to each mortgage payment.

The borrower paying for the lender’s insurance policy might sound unfair at first. But the bright side is that, without it, a homebuyer would need a 20% down payment. The requirement helps the buyer start building home equity years or decades sooner.

Conventional Private Mortgage Insurance (PMI)

Conventional lenders, those regulated by Freddie Mac and Fannie Mae, get mortgage insurance protection from private insurance companies. Hence the name private mortgage insurance, or PMI.

Borrowers who put less than 20 percent down on their new home will usually need to buy PMI. PMI must stay active until the buyer has built up 20 percent equity in the home. Buyers build equity by paying down the loan balance and through the home’s appreciation.

PMI usually costs between 0.25 and 2.0 percent of the loan balance per year. That means for every $100,000 borrowed, PMI adds $500 to $2,000 a year or about $21 to $168 a month.

For a $300,000 loan, it costs about $63 to $504 per month.

Where would your rate fall within this range?

“PMI rates are determined by a complicated algorithm evaluating the overall risk of the transaction,” said Matthew Locke, national mortgage sales manager at UMB Bank.

The lender measures its risk through the borrower’s credit score, credit history, down payment size, current debt load, occupancy type, and the loan’s term, Locke said.

Unlike FHA mortgage insurance, conventional PMI is extremely risk-based. Those with a small down payment or lower credit scores might save a lot of money by choosing FHA.

According to PMI provider MGIC, here’s how much buyers with various scenarios might pay on a $300,000 loan.

Unlike FHA, there is no upfront mortgage insurance premium for conventional PMI, another advantage.

FHA Mortgage Insurance Premium (MIP)

FHA borrowers pay for mortgage insurance to FHA itself, not a private company. The FHA calls its coverage the Mortgage Insurance Premium, or MIP, and it’s required on all FHA loans.

An FHA loan charges MIP in two ways:

• Upfront MIP: This one-time fee adds 1.75 percent to the loan amount. That’s $1,750 for every $100,000 borrowed

• Annual MIP: This every-year fee could range from 0.15% to 0.75% of the loan amount per year (versus 0.25% to 2.0% for conventional PMI). Most new borrowers who pay the minimum 3.5% down pay an annual MIP rate of 0.55 percent. That’s $550 a year, or about $46 a month, for every $100,000 in the loan balance

Based on current FHA lending rules, buyers who put 10 percent or more down on their loans will stop paying annual MIP after 11 years. For buyers who put less than 10 percent down, annual MIP lasts until they pay off or refinance the home.

Since it’s percentage-based, the annual fee decreases each year as the loan balance decreases.

USDA & VA Loan Fees

USDA and VA loans don’t charge mortgage insurance, but they charge service fees that serve the same purpose: providing security so the lender can approve a better deal:

• VA Funding Fee: This one-time fee can range from 1.25 to 3.3 percent of the loan amount. Buyers using their loan benefit for the first time and paying no money down will pay 2.15 percent upfront. VA loans require no ongoing insurance fees

• USDA Guarantee Fee: USDA Guaranteed loans typically charge 1 percent of the loan amount upfront and 0.35 percent of the loan balance per year. Check out our guide to the USDA funding fee to learn more.

Not every buyer can apply for USDA and VA loans. Only active duty military service members and veterans (and some surviving spouses) can use VA loans; only buyers in rural areas with moderate incomes can use USDA loans.

Most buyers compare mortgage insurance fees for conventional and FHA loans.

How PMI and FHA MIP Compare

So which is better? FHA MIP or private mortgage insurance (PMI) on a conventional loan?

The answer depends on the specific borrower — and a lot of variables, including:

Cost

FHA MIP and PMI set their rates differently:

• PMI is risk-based coverage: Riskier borrowers, from the lender’s point of view, pay higher PMI rates than highly qualified borrowers

• FHA MIP charges set rates: FHA lenders care about risk, too, but they assign risk categorically. MIP rates depend mostly on the loan’s term and down payment size, not the borrower’s credentials

This table shows risk-based PMI vs set rate-based MIP in action.

Conventional borrowers with lower credit scores and smaller down payments will usually save money by switching to an FHA loan.

But this table shows only annual insurance fees. Borrowers whose FHA and conventional rates would be about the same should also factor in the FHA’s upfront MIP: 1.75 percent of the loan amount — and the FHA’s cancellation rules.

Cancellation (a Pro for PMI)

A lower monthly premium could still cost more in the long term.

One reason why: PMI on a conventional loan can be cancelled later, once the homeowner pays the loan balance down to 80 percent of the home’s value.

Many current FHA loans do not allow this. FHA borrowers who put 10 percent or more down stop paying MIP after 11 years; borrowers who put less than 10 percent down will pay MIP until they pay off the loan.

These life-of-the-loan MIP borrowers would have to refinance into another type of loan to stop paying MIP.

Discounts for 2+ Borrowers (a Pro for PMI)

Adding a co-borrower can cut PMI costs for conventional borrowers. Having multiple borrowers on the same loan reduces the risk of default. Less risk lowers PMI costs, sometimes by up to $40 per month on a $300,000 mortgage.

Since FHA MIP costs are based on the loan’s term, amount, and down payment size, rates will be the same with one or two borrowers.

Extra Cost for High DTI (a Pro for MIP)

Borrowers with higher debt-to-income ratios (DTIs) typically pay higher PMI rates on conventional loans. For example, a DTI of 45 percent or higher could add $60 extra a month.

FHA MIP won’t reward borrowers with discounts for lowering lender risk, and it also doesn’t punish borrowers for higher DTIs which increase lender risk.

Refunds Available When You Refinance (a Pro for MIP)

FHA borrowers who refinance into a new FHA loan may not have to pay the entire 1.75 percent upfront mortgage insurance premium on their next loan. Part of the upfront MIP paid on the first loan can apply, again, to the second loan.

The amount of this refund depends on the age of the borrower’s current FHA loan. The amount of the refund gradually decreases over the first three years of the loan’s term. By the end of the third year, a loan is no longer refund eligible.

Discounts for Special Programs (a Pro for PMI)

Borrowers who earn 80 percent or less of their area’s median income might qualify for PMI discounts on special conventional loan programs like Freddie Mac’s Home Possible.

Borrowers who meet this income requirement will also need a FICO score of 720 to qualify for a discount. The discount could save about $40 per month on a $300,000 mortgage.

FHA MIP doesn’t offer these types of discounts.

Deciding if FHA or Conventional Is Better

Every borrower has a unique blend of strengths and weaknesses. But, generally:

• FHA MIP is better: for borrowers with lower down payments, higher debt-to-income ratios, and lower credit scores

• Conventional PMI is better: for borrowers with larger down payments, lower debt-to-income ratios, excellent credit scores

But where, exactly, is the cutoff point between these two categories? Since every borrower is different, there’s no way to draw a line that applies, across the board, to every borrower.

When asked where he would draw the line, Locke suggested someone with a credit score under 680 and a debt-to-income ratio over 50 percent would be a clear candidate for FHA.

But he said there’s only one sure way to assess costs.

“The best way to evaluate the difference between FHA and conventional is to find a trusted mortgage loan professional who can provide a complete side-by-side comparison of the programs that would also include the fees and rates associated with each program,” he said.

Still Can’t Decide? Consider Refinancing FHA to Conventional to Cancel Mortgage Insurance Later

Some borrowers may see no clear winner between conventional PMI and FHA MIP. Often these are borrowers whose needs will change as time passes.

For example, let’s say you could save $80 per month with FHA. That’s almost $1,000 a year in savings. Pretty solid. But because of the FHA’s rules, you’ll never be able to cancel this coverage, even if your new home appreciates quickly and you own 20 percent equity in four years.

Should you claim the initial savings of FHA or the long-term savings of conventional PMI?

There is a third option: Saving with FHA now and then refinancing into conventional later, when you no longer need FHA. If you reached the 20 percent equity threshold in four years, for instance, you could refinance the FHA loan into a new conventional that does not require PMI.

This is a common way to bypass FHA rules and cancel MIP. But the new conventional refinance will require closing costs. Be sure to factor those into your equation.

Mortgage Insurance: Extra Costs but Added Flexibility

It makes sense that people complain about mortgage insurance. The coverage protects the lender but charges the borrower.

But money spent on this coverage is usually a solid investment.

Let’s say you pay $120 a month in mortgage insurance. Most likely, this coverage is lowering your monthly payment by a lot more than $120 a month. In fact, there’s a good chance you couldn’t afford your home’s monthly payment without mortgage insurance’s calming effect on your loan.

Without this coverage, most buyers would have to save 20 percent of the home’s purchase price before a lender would be willing to approve a loan for the other 80 percent.

“Mortgage insurance helps give the borrower the ability to put less than 20 percent down on a home,” Locke said. “It can give the borrower the ability to put as little as 3 percent down and still obtain a home loan.”

Ready to compare mortgage insurance costs? Start by checking today’s rates with several lenders.