Mortgage insurance is basically an insurance policy for the bank for loans that have a loan-to-value ratio higher than 80 percent. These loans are considered riskier for banks because they are defaulted on more often than not. A higher LTV means a higher loan amount, less cash down for the bank and a higher rate of loss for the bank should you default on your loan in the future. The most common type of mortgage insurance is Private Mortgage Insurance, or PMI. This insurance is paid on a monthly basis in addition to your principal, interest, taxes and property insurance. Lender paid mortgage insurance, on the other hand, is paid by the lender, but in the end it is still you paying for it.
How Lender Paid Mortgage Insurance is Paid
It is a common misnomer that lenders will pay for certain costs in a mortgage transaction. Despite the name lender paid mortgage insurance, ultimately the borrower is the one paying, the costs are just hidden. The lender has two ways that it can collect the money from you and then they make the actual payment to the insurance company – that is the only lender paid portion that applies. So how do you end up paying these fees if you are not being charged monthly insurance premiums? There are two ways:
- Pay an upfront lump sum – This is similar to paying discount points or an origination fee. Consider the cost another closing cost, one that does not go towards your down payment; it is in addition to it. So if you are putting 5 percent down on a $200,000 loan, you would need to come up with $10,000 for the down payment, plus the lump sum insurance payment. Every amount differs, depending on the mortgage amount, LTV and lender guidelines.
- Pay a higher interest rate – Lenders get paid from the interest that you pay on your mortgage. If you qualify for a 5 percent rate, yet you take a higher rate, the lender gets paid more. That extra money can be used for the lender to pay your mortgage insurance premiums. In essence, you do not have the burden of making PMI payments, but you still are making them, just in a different sense.
Downfalls of LPMI
There are certain negatives to LPMI. If you choose the higher interest rate route, you are stuck with that rate for the life of the loan. This could work to your advantage, should you only plan on staying in the home for 5 years or so. It gives you the opportunity to not pay PMI, yet be able to write off the higher interest payments that you make on your income taxes. If you are going to stay in the home for the life of the loan, however, you are stuck with higher payments every month, which could amount to thousands of dollars of extra money that was unnecessary. The only way out of LPMI is to refinance or pay off the loan, both of which are not always a viable option.
When LPMI Makes Sense
There are certain situations when LPMI makes sense, especially if your LTV is rather high. The closer that you are to 80 percent, the closer you are to being able to cancel your PMI. Many loan programs enable you to have a new appraisal completed and simply cancel your PMI without the need to refinance. This is beneficial if you have a good program and/or rate and will not want to refinance in the near future. On the other hand, if your LTV is closer to 90 or 95 percent, it will take a long time to get down to an 80 percent LTV, which makes LPMI make sense financially, because it is typically a cheaper alternative to monthly PMI.
Talk to your lender about the options that you have if you are putting down less than 20 percent on a home purchase. There are several ways to work the mortgage insurance, each of which has their own benefits. Every situation predicates its own needs – work the process mathematically and decide which type of mortgage insurance will work to your advantage now and well into the future.Click to See the Latest Mortgage Rates»