When it comes to the words mortgage insurance, many people have a negative reaction because they think it is bad. Is mortgage insurance bad? Maybe, maybe not.
Mortgage insurance is required whenever the down payment for a home is less than 20% of the home’s purchase price. This may happen if the home buyer does not have enough cash for the down payment or simply because they want to keep some cash for repairs, remodeling, etc.
The beauty of mortgage insurance is that it allows people to own homes even if they do not have enough money for a down payment. But of course, it comes at a price in the form of private mortgage insurance (PMI).
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What is PMI?
PMI is a type of insurance required by lenders as a condition for a mortgage loan. Borrowers pay this insurance from a third-party mortgage insurer. This type of insurance protects the lender in the event that the borrower fails to make payments and defaults on the loan. It is an extra cost a borrower has to pay on top of their home loan.
The PMI cost depends on the borrower’s credit score, the loan term, the down payment made, and the mortgage. Borrowers must make the monthly payments until they have accumulated enough equity in the home, roughly about 22% of the home’s purchase price. Once that is reached, there is no more need to have a PMI and no more payments.
But one thing that many people aren’t aware of is that it is possible to avoid having to pay mortgage insurance on a loan by restructuring the payments using lender-paid mortgage insurance (LPMI).
What is LPMI?
LPMI is normally available only on conventional loans. The idea of having a LPMI is relatively simple: The lender buys the mortgage insurance and the homeowner accepts a higher interest rate on their mortgage loan. What happens is that the monthly loan payment increases, but usually it is not as much as if it were a PMI.
Another good thing about LPMI is that the mortgage interest payments are tax deductible for filers who itemize their deductions. And since the interest rate will be higher on the loan, it is possible to get a higher mortgage interest deduction. That could mean more money back during tax time.
And when you do the math, it is possible that getting a LPMI on a loan could save a chunk of money on each month’s mortgage payment.
One of the problems with LPMI is that, technically, the homeowner will be paying for the insurance; the structure of the payments simply changes. Instead of normal insurance payments, the homeowner either pays a lump sum upfront or makes a larger payment every month. In either instance, however, it may end up less than getting a PMI separately.
LPMI example: conventional mortgage loan
Here is a simple example of what LPMI might look like for a conventional mortgage loan.
- $200,000 purchase price
- 10% down payment
- 750 credit score
- 30-year fixed rate of 4.875%
Option 1: standard monthly MI
- $971 principal & interest
- $84 monthly mortgage insurance
- $1,055 total
Option 2: upfront premium paid by borrower or seller is $3,574
- $971 principal & interest
- $84 monthly savings
- $9,504 10-year savings
Option 3: borrower takes a higher interest rate of 0.375% or 5.25% in exchange for no monthly MI
- $1,013 principal & interest
- $42 monthly savings
The pros of LPMI
- Monthly savings. The mortgage insurance is spread out over the life of the loan so homebuyers may not pay as much monthly, especially at the beginning of the loan.
- Qualify to borrow more. Another benefit to LPMI is that borrowers can actually qualify for a larger mortgage since their monthly payments are less.
The cons of LPMI
- Cannot be canceled without refinancing. Since the LPMI is baked into the loan, it is not possible to pay it off unless the homeowner pays off the entire mortgage (which is easier said than done) or refinances the loan.
- Interest rate increases. The rate might increase over time, and it eventually could cost more than a PMI would.
- Often requires good credit. Having extremely good credit is one of the requirements to qualify for a LPMI. Lenders consider this because the higher the credit score, the less likely the borrower will default on the loan. It is something that the lender will take into consideration before agreeing to a LPMI.
- Not all lenders offer LPMI. If the homebuyer plans on putting less than 20% down and will need to apply for a LPMI, they should make sure that the lender offers LPMI. (It should be one of their first questions actually.) But there are lenders out there that do not require any kind of mortgage insurance, so homebuyers should do their research.
How to get rid of LPMI
The LPMI cannot be canceled and it will have to be paid over the life of the loan. The only way to lower payments is to refinance the loan.
Once the homeowner reaches 20% equity, then they can apply for refinancing to lower the interest rate (and the monthly payment) with their current lender or another.
Mortgage insurance costs a little extra, but it enables homebuyers to purchase a property and move into a home sooner rather than later. The insurance lowers the risk for lenders but increases the likelihood of homeownership.
Is LPMI the right choice? The monthly savings can be dramatic and it may be the difference of qualifying for the home and not qualifying. Homebuyers need to work with their loan officer so they are fully informed and make the best decision for their situation.