If you’re currently shopping for a new home or considering it in the near future, it’s important to understand the various provisions of your mortgage. One term you may see in your documents is the arrangement for mortgage insurance, which is paid for by either the borrower or the lender. Lender-paid mortgage insurance does have certain benefits, so it’s worth considering for your home financing. Here are the answers to some common questions.
What is Lender-Paid Mortgage Insurance (LPMI)? In general, mortgage insurance is intended to protect the lender if a borrower defaults on a home loan. Most lenders require mortgage insurance if a borrower pays less than 20% down payment for the loan. You can opt to get private mortgage insurance (PMI) or agree to lender-paid mortgage insurance. With LPMI, your lender pays the mortgage insurance premium on your behalf and passes the cost on to you, usually in the form of a higher interest rate.
- Pros: Because mortgage payments are tax deductible, you take advantage of preferential tax treatment with an LPMI. If you opt for PMI, these payments are not deductible. Plus, PMI may be unavailable to you if your credit score is low or you have a higher loan-to-value ratio.
- Cons: The interest rate for LPMI is higher as compared to if you went to a PMI broker. In addition, PMI can be eliminated entirely if and when your equity in the home reaches 20% or more. With LPMI, the amount you pay for the policy will continue for the life of the loan.
How does LPMI work? To better understand how LPMI works, here are some examples where a borrower doesn’t have the required 20% down payment and must obtain mortgage insurance.
- Private Mortgage Insurance: You may opt for PMI if you’re eligible with a high credit rating and lower loan-to-value ratio. Your mortgage interest rate on a $225,000 loan is 4.5%, with a 30-year fixed plan and payment of $1,140; PMI adds $83 for a total monthly payment of $1,223. You can drop the PMI after 7+ years because you’ve hit the required 20% value. At the end of the 30 years, you will have paid $417,509.
- LPMI: If you don’t qualify for PMI or simply choose to go with lender-paid mortgage insurance for a 30 year fixed loan, your situation is slightly different. Your interest rate is 4.75% to cover the upfront cost of the policy, making your monthly payments $1,174. You don’t pay for mortgage insurance at all, so hitting the 20% value of your home is irrelevant. At the end of the 30-year mortgage agreement, you will have paid $422,536.
The cost difference between these two arrangements is $5,027 more for the LPMI option, which some homeowners may find to be a negligible amount over 30 years.
These answers to frequently asked questions should be helpful, but they’re not intended to replace professional advice. The choice of borrower or lender-paid mortgage insurance is very case specific and based on your individual circumstances, so consult with a mortgage equity expert to determine the right arrangement for you.